Proposed hardship distribution guidance

The Treasury department published proposed regulations in the Federal Register on November 14, 2018 to address changes made to hardship distribution guidelines under the Bipartisan Budget Act of 2018 (BBA), the 2017 tax law known as the Tax Cuts and Jobs Act (TCJA), and the Pension Protection Act of 2006 (PPA). The proposed regulations also include relief for individuals affected by Hurricanes Florence and Michael.

Proposed not yet final

It is important to note that these regulations are proposed, are open for comments, and will not be finalized until sometime in 2019. Often regulations that are proposed will state that taxpayers may rely on the proposed regulations as if they are final with the understanding that any changes made from the proposed to the final version may require adjustments. However, the proposed regulations did not include a clear statement allowing reliance before they are finalized. That being said, it seems that much of the substance of the proposed regulations is unlikely to be changed significantly before being finalized. Plan administrators may wish to consider implementing these changes for 2019 or start planning to implement them in 2020. Plan sponsors who already made changes to their plan documents should review their amendments to ensure compliance with the proposed regulations, and again when the regulations are finalized.

Hardship distribution changes under proposed regulations

Change Six-month contribution suspension following hardship distribution: Eliminates the six-month suspension of elective deferrals following receipt of a hardship distribution.
Required or Optional Required of all plans with transition relief.
Effective Date1 Optional for plan years beginning after December 31, 2018. Required for distributions on or after January 1, 2020.
Change Loan requirement to satisfy immediate and heavy financial need: Eliminates the requirement that a participant must take all nontaxable loans under the plan and all other plans maintained by the employer prior to a hardship distribution.
Required or Optional Optional
Effective Date1 May be applied for plans beginning after December 31, 2018.
Change Contribution sources available for hardship: Hardship distributions may be drawn from earnings on elective deferrals, “qualified matching contributions” (QMACs) or “qualified nonelective contributions” (QNECs), “qualified automatic contribution arrangements” (QACA) and the earnings on these contribution types as well.
Required or Optional Optional
Effective Date1 May be applied for plans beginning after December 31, 2018.
Change Clarification on casualty loss definition: Hardship withdrawals for expenses related to the repair of a principal residence that qualifies for the casualty loss deduction under Code Section 165 will continue to be determined without regard to the change made by the Tax Cuts and Jobs Act (which otherwise would have limited hardships for principal residence repairs to losses incurred in federally declared disaster areas).
Required or Optional Required with transition relief for 2018.
Effective Date1 Plan years beginning after December 31, 2018. Distributions during 2018—plans could apply the more restrictive definition under the Tax Cuts and Jobs Act (TCJA), or use the definition of IRC Section 165 prior to the change under the TCJA.
Change Expanded disaster hardship event for immediate and heavy financial need (Natural Disaster Safe Harbor): A new safe harbor hardship distribution option that may be based on expenses and losses (including loss of income) incurred after federally-declared disasters (as long as the participant’s home or principal place of business at the time of the disaster was located in an area designated for federal assistance by FEMA).
Required or Optional Optional
Effective Date1 May be applied for plans beginning after December 31, 2018.
Change New participant representation: Participant must provide a written representation (which may be electronic) that he or she has insufficient cash to satisfy the financial need, and the plan administrator may rely on such representation.
Required or Optional Required
Effective Date1 For all distributions made after January 1, 2020.

Additional information on new employee representation

Because the BBA removed much of the safe harbor rules for determining that a distribution is necessary to satisfy the financial need (i.e. by removing the six-month contribution restriction and the need to take all available loans), the proposed regulation would provide two conditions in lieu of the prior rules:

1 The employee must obtain all other currently available distributions (including distributions of ESOP dividends under section 404(k), but not hardship distributions) under the plan and all other plans of deferred compensation, whether qualified or nonqualified, maintained by the employer.
2 The employee must represent in writing (which may be electronic) that he or she has insufficient cash or other liquid assets to satisfy the need. This second rule is new, so the proposed regulations state that it is required only for distributions made on or after January 1, 2020. The regulations state that the plan administrator may rely on the employee’s representation “unless the plan administrator has actual knowledge to the contrary.”

Guidance on PPA items

The PPA made two changes that have now been incorporated into the 401(k) regulations.

PPA directed Treasury to modify the rules relating to hardship distributions to permit a section 401(k) plan to treat a participant’s beneficiary under the plan the same as the participant’s spouse or dependent in determining whether the participant has incurred a hardship.
PPA permits a 401(k) plan to make “qualified reservist distributions.”
Our prototype document has been updated.
Plan sponsors with custom documents should check with their legal counsel to ensure their documents are up to date.

1 Clarification on effective dates: Under the BBA changes were set to go into effect for plan years beginning on or after January 1, 2019, which created certain challenges prior to the publication of the proposed rule as guidance from Treasury is needed on a number of questions that have arisen. The proposed regulations attempt to address this problem with delayed effective dates, but provide the option for plan sponsors to apply changes earlier if they so choose.