IRS Issues Proposed Regulations to Relax 401(k) Plan Hardship Distribution Rules
The IRS recently issued proposed regulations to implement changes to the rules for hardship distributions from 401(k) plans made by the Bipartisan Budget Act of 2018 (“BBA”) that will take effect on January 1, 2019. The proposed changes will make hardship distributions more widely available and will ease administration of hardship distributions for plan sponsors. While employers may implement some of these changes retroactively to apply as of January 1, 2018, plans need not be amended this year for any of the changes. This alert explains the mandatory and optional plan changes, and optional effective dates for each change.
Implementation of BBA Changes
Generally, 401(k) plans can provide for hardship distributions to active employee participants, if necessary to satisfy an immediate and heavy financial need. However, plans currently are required to impose restrictions and conditions that can make hardship distributions difficult for participants to obtain and administratively complex. The proposed changes will relax some of those restrictions.
The proposed regulations contain both mandatory and optional changes to the hardship distribution rules.
Broader List of “Safe Harbor” Events
Under current “safe harbor” rules, a plan may provide that a hardship is deemed to exist, if the distribution is for one of several enumerated reasons. The proposed regulations would make three changes to the safe harbor rules:
This last provision corrects an inadvertent change made by the Tax Cuts and Jobs Act (“TCJA”), which revised Code section 165 to limit the casualty deductions to losses resulting from federally declared disasters, effective for tax years between 2018 and 2025. This meant that hardship distributions to pay for damage to a participant’s home would be limited to situations where the damage resulted from a federally declared disaster, effective as of January 1, 2018. Under the proposed regulations, plans can be amended to include this corrective provision as of January 1, 2018, so that any hardship distribution made after that date would not be affected by the TCJA change to Code section 165.
Elimination of “Facts and Circumstances” Test for Alternative Relief Sources
Under the current rules, a plan sponsor must determine whether a hardship may be relieved from other sources that are reasonably available using a “facts and circumstances” test. The proposed regulations would replace that test with a general standard, under which:
Timing of Plan Amendments and Optional Effective Dates
All plan revisions related to the proposed regulations will be treated as “integrally related” to the required change to the six-month suspension rule, so there will be only one plan amendment deadline for all plan changes, even those that are optional. Based on the proposed regulations, and required adoption deadlines set forth in IRS guidance, this means that plan amendments for both governmental and non-governmental plans to implement the changes will not be required until 2021, at the earliest.
Prior to adopting an amendment, plan sponsors may apply the following effective dates for the new rules:
Hanson Bridgett’s employee benefits practice group will monitor the rule-making process, and will notify clients when the regulations become final.
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