IRS releases hardship withdrawal guidance
The Treasury Regulations from the Internal Revenue Service (IRS) regarding hardship withdrawals have finally been released. Plan sponsors who permit plan participants to take hardship withdrawals should review their 401(k) and 403(b) plans to determine whether a plan amendment may be necessary and what changes may be needed for existing administrative practices.
Treasury Regulation Section 1.401(k)-1(d)(3) (Final Regulations), implements the changes Congress made through the Bipartisan Budget Act of 2018 (Budget Act), which:
- Removes the six-month prohibition on elective deferrals after a hardship withdrawal.
- Includes qualified non-elective contributions, qualified matching contributions, and profit-sharing contributions as available funds for hardship withdrawals.
- Eliminates the requirement that participants take out plan loans prior to a hardship withdrawal.
- Allows participants to make a hardship withdrawal for certain expenses incurred by their “primary” beneficiaries.
Participants now have significantly easier access to the cash balances in their 401(k) and 403(b) accounts when a hardship occurs. The Final Regulations allow a plan administrator to rely on a participant’s written, self-certification that the participant has insufficient cash or other liquid assets to satisfy the financial need, unless the plan administrator has actual knowledge to the contrary. More detail on the Final Regulations is provided below.
Additionally, in 2017, the IRS issued a memorandum to its agents providing guidelines for reviewing hardship distributions during an examination of a 401(k) plan. Specifically, the guidelines address the process an examining agent should follow to ensure hardship distributions were properly made, particularly in instances where the plan sponsor does not obtain source documents supporting a participant’s hardship at the time distributions are made, but rather relies on the participant’s self-certification. While this memorandum is not a “pronouncement of law” and cannot be relied upon, it provides plan sponsors with insight into how the IRS intends to apply the Internal Revenue Code’s rules related to self-certified hardship distributions.
Suspension on elective deferrals following a hardship withdrawal is no longer required
A plan document may be amended to no longer preclude a participant from contributing to the participant’s account following a hardship distribution for any hardship distributions made after December 31, 2018. This allows a participant to receive a hardship withdrawal and continue to contribute to the plan if they are able to. Plan sponsors may retain the suspension requirement through the end of 2019, but must remove the requirement by January 1, 2020.
Available funds for hardship withdrawal
Under the Final Regulations, plan sponsors are permitted, but not required, to amend their plans to allow for hardship distributions from the following sources:
- Profit-sharing and stock bonus contributions (including earnings on such contributions).
- Qualified non-elective contributions (including earnings on such contributions).
- Qualified matching contributions (including earnings on such contributions).
An amendment to include distributions from these sources may be effective as early as Jan. 1, 2019.
While 403(b) plans generally follow the hardship distribution rules applicable to 401(k) plans, hardship distributions from a 403(b) plan still may not include investment earnings on 403(b) elective deferrals under code section 403(b)(11).
Participant loans prior to a hardship withdrawal are no longer required
The Proposed Regulations permit, but do not require, a plan to allow a hardship distribution without first requiring the participant to take a loan against the participant’s account. Plan sponsors that wish to allow hardship distributions without imposing a loan requirement must adopt an amendment covering this update. This discretionary amendment can be adopted at any time.
Participants can now make a hardship withdrawal for expenses incurred by their beneficiaries
The “primary beneficiaries” of a participant can now receive the benefit of a participant’s hardship distribution. A primary beneficiary is an individual who has an unconditional right to the participant’s account upon the participant’s death. The primary beneficiary is not required to be a relative of the participant. A hardship withdrawal is permitted for the primary beneficiary’s qualifying educational, medical or funeral expenses.
IRS guidance on hardship documentation self-certification/e-certification
In 2017, the IRS’ Tax Exempt and Government Entities Division issued a memorandum to its agents, which provided guidelines for determining, on examination of a 401(k) plan, whether a hardship distribution is “deemed to be on account of an immediate and heavy financial need.” The guidance outlines the requirements applicable to plans, which use a summary of information from the participant requesting a hardship distribution as substantiation of the hardship (self-certification).
If a plan permits self-certification, the plan sponsor must provide the participant (either directly or through the plan’s third-party administrator) the following notifications prior to making a hardship distribution2:
- The hardship distribution is taxable and additional taxes could apply.
- The amount of the distribution cannot exceed the immediate and heavy financial need.
- The recipient agrees to preserve source documents and to make them available at any time, upon request, to the employer or administrator.
The final bullet generally causes plan sponsors and benefit plan auditors concern. The plan sponsor would be required to provide the source documents upon request by the plan’s independent auditor, or by an IRS agent in the event the plan is under IRS examination. Failure to substantiate the validity of a hardship distribution upon IRS examination may be considered a qualification failure and subject the plan sponsor to sanctions or jeopardize the qualified status of the plan.
There are certain informational requirements (“self-certification information”) when self-certification is utilized, which include:
- Participant’s name,
- Total cost of the event causing hardship (e.g., total cost of medical care, total cost of funeral/burial expenses, payment needed to avoid foreclosure or eviction),
- Amount of distribution requested, and
- Certification by the participant that the information provided is true and accurate.
The IRS may seek source documents (substantiating the hardship distribution):
- If the self-certification information provided by the participant (at the time of the hardship distribution) is incomplete or inconsistent.
- If the self-certification information provided is complete and consistent, but the IRS agent finds participants who have received more than two hardship distributions in a plan year, absent an adequate explanation for the multiple distributions.
If an IRS agent determines that all self-certification information requirements are satisfied, the plan should be treated as satisfying the substantiation requirements for making hardship distributions on account of an immediate and heavy financial need.
Plan sponsors should take care to ensure the self-certification information is complete and consistent and maintained. As a best practice, a plan sponsor should require a participant to scan the source documents to the plan sponsor or third party administrator at the time the self-certification is made. This will mitigate the need to obtain documentation from a participant, potentially years after the hardship distribution occurs.
The Tax Cuts and Jobs Act had eliminated the casualty loss deduction for any loss not incurred because of a federally declared disaster. The Final Regulations restore the casualty loss hardship distribution to allow participants to take a hardship withdrawal for such losses without waiting for the IRS to issue special guidance, so long as it occurs in an area designated by the Federal Emergency Management Agency (FEMA).
Plan sponsors that have questions regarding this IRS guidance, should contact a member of Plante Moran’s Employee Benefits Consulting group for further assistance.
2 The original notification requirements also included a provision that indicated “hardship distributions cannot be made from earnings on elective contributions or from QNEC or QMAC accounts, if applicable.” This notification requirement became no longer necessary due to the Bipartisan Budget Act of 2018 discussed above (which allows distributions on the earnings and those accounts).