Blog
March 4, 2019
New Rules for Hardship Distributions
Effective January 1, 2019
When an employee participating in their company’s 401(k), 403(b), or Profit Sharing Plan has a financial need, most plans have a participant loan provision. If the financial need amounts to an “immediate and heavy financial need,” the plan can allow for a hardship distribution.
Under prior rules, a plan participant was required to take a participant loan, before they could take more of their money by means of a hardship distribution. Also, the employer had to stop their contributions to the plan for six months. These two rules are no longer a requirement.
Under newly proposed regulations, a participant is no longer required to take a loan prior to taking a hardship distribution, and a participant does not have to stop making contributions to the plan for six months.
Hardship Distributions are described in the Plan’s legal document and 2019 is a transition year, in which the employer can still follow the old procedure or switch to the new one with a plan amendment.
As an employer, sponsoring the plan this is your decision. You can still require the employee to take a loan before a hardship is available or you can give them their funds under the new hardship rule. Loans are not taxed and must be repaid over five years and up to 15 years for a home loan. Hardships are fully taxed in the year taken, and if you are under age 59 ½, a 10% excise tax imposed by the government.
New Hardship Rule
Hardship distributions must be for an “immediate and heavy financial need” and must also meet these three requirements:
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The distribution must not exceed the amount of a participant’s need , however it may include the taxes and expenses associated with the hardship distribution
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The participant has obtained all other currently available distributions under the plan and all other plans of deferred compensation (whether qualified or nonqualified), is maintained by the employer
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For a distribution that is made on or after January 1, 2020, the participant must represent in writing he or she has insufficient cash or other liquid assets to satisfy the need. The employer may rely on the participant’s representation unless the employer has actual knowledge to the contrary.
The proposed regulations also modify the safe harbor list of expenses under current law, for which distributions are deemed to be made on account of an immediate and heavy financial need. By adding “primary beneficiary under the plan” as an individual for whom qualifying medical, educational, and funeral expenses may be incurred.
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By adding that damage to a principal residence, which would qualify for a casualty deduction under Section 165 and does not have to be in a federally declared disaster area
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By adding a new type of expense to the list, relating to expenses incurred as a result of certain disasters
The IRS says the latter is “intended to eliminate any delay or uncertainty concerning access to plan funds following a disaster that occurs in an area designated by the Federal Emergency Management Agency (FEMA) for individual assistance.”
What is the best way to go?
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Is a loan a better option if there is enough money in the account to satisfy the employee’s financial need?
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Does the employee really have an immediate and heavy financial need that can’t be satisfied through other assets they have?
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Should the distribution be made up of part loan and part hardship?
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Loans get repaid and keep the employee on target for saving for retirement.
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A hardship distribution is taxable and doesn’t have to be repaid.
To make the change to the new rule, the plan document requires an amendment. We do not have the final language approved by the government at this time, but you can create a resolution indicating you will amend your plan document when language is available.
Your plan representative at BEI is always available to answer any questions you have about plan operations and please contact us early at 800-899-9141 or email us at planservices@benefitequity.com.
Author: Robert Gorelick, APA, Founder Benefit Equity Inc.
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