Articles

New Hardship Rules, Other Statutory Changes Reflected in Newly Proposed 401(k) Regulations

Nov 19, 2018

The Treasury Department has issued proposed regulations that provide guidance on changes to the hardship distribution rules made by the Bipartisan Budget Act of 2018 (BBA). The proposed regulations also include changes to reflect provisions of earlier legislation. Plan documents must be amended to delete any language that conflicts with required changes, and to adopt any optional rules, by the end of the second plan year that begins after final regulations are included in the Required Amendments List issued by the IRS.

Hardship Provisions. The proposed regulations expand the types of events that automatically qualify as a hardship and simplify the steps plans must take when deciding whether a distribution is necessary to meet a hardship. The regulations also provide guidance regarding the amounts that may be distributed from the participant's account to satisfy the hardship.

Expenses that qualify as a hardship. Existing regulations identify specific types of events that automatically qualify as a hardship (the "safe harbor" hardship events). Those include medical expenses, purchase of a principal residence, payment of tuition and room and board expenses for post-secondary education, prevention of eviction or foreclosure, funeral expenses, and casualty losses. Under the proposed regulations, (i) medical, educational and funeral expenses for a primary beneficiary who is not a dependent may constitute a hardship, (ii) hardship distributions for casualty losses can be made without regard to whether the casualty loss is attributable to a federally-declared disaster, and (iii) expenses incurred as a result of a federally-declared disaster now qualify as a safe harbor hardship event if the employee's principal residence or place of employment was, at the time of the disaster, located in an area designated for individual assistance by the Federal Emergency Management Agency (FEMA).  The regulations retain a plan's ability to permit distributions for expenses other than the safe harbor events based on a review of the relevant facts and circumstances. The expanded list can be implemented for distributions made on or after January 1, 2018. 

The stance taken by the IRS with regard to hardship distributions for casualty losses was unexpected. As background, prior to enactment of the 2017 Tax Cuts and Jobs Act, a taxpayer could claim a tax deduction for casualty losses that exceeded 10% of adjusted gross income. But, under that act, for tax years between 2018 and 2025, a casualty loss deduction is permitted only for casualty losses associated with a federally-declared disaster. It was believed that a hardship distribution for a casualty loss would also have to be limited to casualty losses attributable to a federally-declared disaster. However, the proposed regulations provide that a casualty loss hardship distribution can be made even if the casualty loss is not attributable to a federally-declared disaster.   

Determining whether a hardship distribution is necessary to meet a qualifying expense. Currently, plans can decide a distribution is necessary to meet a qualifying expense in one of two ways. First, the plan can review the relevant "facts and circumstances" to determine the employee does not have other resources to meet the need (usually including getting a representation from the employee that the need cannot be met by liquidation of assets, cessation of plan contributions, taking available distributions and plan loans, or borrowing from commercial sources). Alternatively, the plan can follow "safe harbor" rules that deem a distribution necessary if the employee first obtains all other currently available distributions and non-taxable loans and is prohibited from making contributions to all deferred compensation plans of the employer for at least six months following the distribution. 

Under the proposed regulations, the "facts and circumstances" method has been eliminated. For hardship distributions made on or after January 1, 2020, a distribution is treated as necessary to meet a qualifying expense only if (i) the employee first obtains all currently available distributions from all qualified and non-qualified plans maintained by his or her employer and (ii) represents that he or she has insufficient liquid assets to satisfy the expense. The prior requirements to first take all available non-taxable loans, and to suspend contributions for six months, have been eliminated. A plan may continue to require the employee to first take other steps before granting a hardship (e.g., taking plan or commercial loans, liquidating assets, etc.) However, for hardship distributions made on or after January 1, 2020, a plan may not require the employee to stop contributions for six months in order to obtain a hardship distribution.

Note that the proposed regulations allow (but do not require) plans to eliminate the requirement to suspend contributions for six months on the first day of the first plan year beginning on or after December 31, 2018, even if the hardship distribution was made prior to that date.   

Available Sources for Hardship Distributions. The proposed regulations reflect that hardship distributions made in plan years beginning after December 31, 2018 can now be made from elective deferrals, Qualified Non-Elective Employer Contributions (QNECs) and Qualified Matching Contributions (QMACs) (including traditional safe harbor contributions), and earnings on those amounts, regardless of when contributed or earned. They clarify that safe harbor contributions to a qualified automatic contribution arrangement may also be a source for hardship distributions. The regulations do not require plans to make these additional sources available for hardship distributions: plans may limit the types of contributions from which hardship distributions can be made, and may include or exclude earnings. 

As expected, the proposed regulations confirm that 403(b) plans (i) may not make earnings on elective deferrals available for hardship distribution, and (ii) QNECs and QMACs held in a 403(b)(7) custodial account may not be made available for hardship distribution (QNECs and QMACs in a 403(b)(1) annuity contract may be made available for hardship distribution). Many believe this was an oversight by Congress, and that future legislation will permit 403(b) plans to make hardship distributions from the same sources as may be made available under 401(k) plans.

Disaster Relief for Hurricanes Florence and Michael. The proposed regulations extend to victims of Hurricanes Florence and Michael the limited relief previously provided in Announcement 2017-15 to victims of Hurricane Maria. This means that a 401(k), 403(b), or governmental 457(b) plan may make a loan or a hardship distribution for a need arising from Hurricanes Florence or Michael even if the plan document does not currently provide for loans or hardship distributions.  Only an employee or former employee whose principal residence or place of employment was located in one of the areas identified for individual assistance by FEMA (or whose lineal descendant or ascendant, dependent, or spouse had a principal residence or place of employment in one of those areas) on the dates specified in the emergency declaration may take advantage of this relief. You can determine whether a particular county was identified as eligible for individual assistance by going to https://www.disasterassistance.gov and entering the name of a city or state.  

Under this disaster relief, only sources otherwise permitted to be distributed for hardship or unforeseeable emergency can be distributed, and the distribution must be limited to the maximum amount permitted for such distributions under current law. However, plans are not required to suspend employee contributions in connection with a hardship distribution, and can disregard procedural rules normally required in issuing loans or hardships (e.g., spousal consent, supporting documentation, etc.) so long as they make reasonable efforts to comply with those requirements as soon as possible.

Other Changes. The proposed regulations also add language to reflecting changes made by prior legislation. For example, the proposed regulations provide that (i) a qualified reservist distribution is a permissible distribution event from a 401(k) plan, and (ii) a suspension of contributions imposed in connection with a distribution to a participant performing military service (who is treated as having a severance of employment) is permissible in a safe harbor plan.

Action Steps. Newport Group is currently assessing the proposed regulations and a feasible timetable for implementing related operational and administrative processes. Please contact your relationship manager for the most recent information regarding these changes. 

 

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Newport Group, Inc. and its affiliates provide recordkeeping, plan administration, trust and custody, consulting, fiduciary consulting, insurance and brokerage services. Fiduciary consulting services are provided through Newport Group Securities, Inc., an SEC-registered investment adviser and FINRA-registered broker-dealer, and Newport Group Consulting, LLC, an SEC-registered investment adviser. Newport Group Securities, Inc. and Newport Group Consulting, LLC are affiliates of Newport Group, Inc. All securities transactions are provided through Newport Group Securities, Inc., in its role as broker-dealer. All fiduciary consulting services are provided through the registered investment advisers. When offering variable insurance products, Newport Group Securities, Inc. acts solely in its capacity as a broker-dealer. Trust and custody services provided by Newport Trust Company, a New Hampshire state chartered trust company and wholly owned subsidiary of Newport Group, Inc.