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IRS Finalizes Regs to Changes to Hardship Distribution Rules

In the Bipartisan Budget Act passed in February 2018 (“Act”), Congress loosened certain restrictions on hardship distributions from 401(k) and 403(b)plans. The IRS previously issued proposed regulations and has now published final regulations with a few changes from the proposed regulations.

The final regulations, consistent with the Act and the proposed regulations, eliminate the 6-month suspension period for employee contributions (including pre-tax deferrals, Roth deferrals, and after-tax contributions to 401(k), 403(b), and eligible governmental 457(b) plans) for hardship distributions made on or after January 1, 2020. Plan sponsors are permitted, but not required, to eliminate the suspension period for hardship distributions made in plan years beginning on or after December 31, 2018. The final regulations clarify that non qualified deferred compensation plans subject to Code Section 409A are not subject to the prohibition on suspension of employee contributions; non qualified deferred compensation plans may eliminate a suspension period provided such action is consistent with Code Section 409A and the regulations thereunder.

The IRS also finalized the language in the proposed regulations permitting (but not requiring) plan sponsors to eliminate the requirement that plan loans be taken before hardship distributions, effective for plan years beginning after December 31, 2018.

Additionally, the final regulations, consistent with the Act and the proposed regulations, permit (but do not require) plan sponsors to allow hardship distributions from qualified non elective contributions (“QNECs”), qualified matching contributions (“QMACs”), safe harbor contributions, and the earnings on those sources and on elective deferrals. These additional sources are more limited for 403(b) plans; earnings on 403(b) deferrals continue to be ineligible for hardship distributions, and only QNECs and QMACs held in non-custodial accounts (e.g., 403(b) annuities) are eligible for hardship distributions.

To reflect the change to the casualty deduction made by theTax Cuts and Jobs Act (“TCJA”), the final regulations clarify that the TCJA change does not apply to hardship distributions. Therefore, a hardship distribution for the purpose of repairing damage to a principal residence that would qualify for a personal casualty deduction under Code Section 165is still available even if the casualty is not due to a federally declared disaster. Employers could apply the TCJA limitation to hardships for 2018 and 2019, but effective January 1, 2020, the limitation no longer applies.

The final regulations also added an additional safe harbor withdrawal event for disaster events. The regulations permit withdrawals for a participant’s expenses or losses incurred due to a federally declared disaster. This provision is intended to replace future disaster-relief announcements from the IRS, and is more limited than previous disaster-relief announcements in that it does not cover expenses and losses of the employee’s relatives and/or dependents.

Action Item: Plan Amendment

Plan sponsors should review their documents and hardship distribution procedures. The deadline to amend plan documents to reflect required changes depends on the type of plan.

  • Individually designed non-governmental plans:

    • The amendment deadline is the end of the second calendar year that begins after the issuance of the Required Amendments List (“RAL”) that includes the change; if the hardship changes are on the 2019 RAL, the deadline will be December 31, 2021.

  • Pre-approved 401(k) plans:

    • The amendment deadline is the tax-filing deadline (including extensions) for the 2020 tax year. This deadline applies even if the pre-approved plan implemented the new provisions earlier than January 1, 2020. Contact your pre-approved document provider for information about this amendment.

  • Pre-approved 403(b) plans:

    • The remedial amendment deadline is March 31, 2020, though the IRS indicated that it is considering a later amendment deadline for hardship changes, which would be issued in separate guidance.

Note that for safe harbor plans, if the new hardship rules were not described in the 2020 safe harbor notice, employees must be provided an updated notice to reflect the new hardship withdrawal provisions and must be given the opportunity to change their election. Generally, mid-year safe harbor change notices must be provided at least 30 days (and not more than 90 days) before the effective date of the change. In this case, it is likely not practicable to provide the notice in advance of the January 1, 2020 effective date of the plan amendment, in which case the notice should be provided as soon as practicable, but no later than 30 days after the amendment is adopted.

If you have any questions about the new hardship regulations, please contact a Boutwell Fay attorney.

© Boutwell Fay LLP 2019, All Rights Reserved.This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us.The information contained in this article is effective as of November30, 2019.

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