IRS Finalizes New Hardship Distribution Rules

March 07, 2020

In October 2019, the IRS responded to the Tax Cuts and Jobs Act of 2017 and the Bipartisan Budget Act of 2018 through its release of the final amendments to the hardship distribution regulations.  Thanks to these newly-amended regulations, plan sponsors will now have new customization options for their plan’s hardship distribution rules.  There are also provisions of these amended regulations that will require some administrative changes that plan sponsors will need to start implementing as early as January 1, 2020.

We’ve summarized the major implications for most plan sponsors in this article.

Hardship Deferral Suspension Eliminated – Mandatory

Starting January 1, 2020,  plans are no longer permitted to suspend participants from making salary deferrals into their retirement plan account after taking a hardship distribution.  Previously, sponsors could suspend participants from making deferrals for 6 months after taking a hardship withdrawal.  The original thinking was that if an employee truly needs to take a hardship withdrawal, then they should also suspend their salary deferrals to increase their take-home pay.  However, legislators have made it clear through this rule change that they’re more concerned with workers’ ability to retire than before.

This new rule means that participants who take hardship withdrawals after 12/31/2019 can’t be suspended from making deferrals.  However, hardships taken during 2019 that already have a suspension in progress would still apply the suspension until its expiration date, even if the expiration date is in 2020.

Removal of Requirement to Take Loans and Other Forms of Distributions First – Optional

The newly-issued rules now eliminate the requirement for a participant to exhaust their other forms of distributions and loans available under the plan before taking a hardship.  Since this change is optional, plan sponsors can customize their plan to suit their preference.

Ease of Hardship Verification – Optional

Plan sponsors can now rely on a written certification statement from the participant instead of having to review supporting documents to make a hardship determination. This will certainly make it easier for sponsors to fulfill their duties, but it may introduce more frequent abuse of the hardship withdrawal feature in their plan.  However, sponsors are still prohibited from authorizing a hardship withdrawal if they have knowledge that the participant’s need would not qualify for a hardship.

Availability of Earnings in Hardship Amount – Optional

Previously, hardships could only be taken from the principal contributions made to a participant’s retirement plan account. But the new rules have now expanded the amount available for hardship to include earnings as well.

New Safe Harbor Hardship Event for Federally-Declared Disasters

Traditionally, the IRS has maintained a safe harbor list of six safe harbor hardship events that qualified a participant as being in immediate and heavy financial need.  This list has consisted of the following events:

  • Expenses related to post-secondary education for the participant, spouse, or children in the next 12 months

  • Prevention of foreclosure of a primary residence 

  • Purchase of a primary residence 

  • Repairs or improvements to a primary residence 

  • Funeral expenses 

  • Medical expenses not covered by insurance

However, a new seventh safe harbor hardship reason has been added to make hardships available for expenses related to federally-declared disasters in an area determined by FEMA.

The changes to hardship withdrawals are designed to make it easier for participants to access their retirement account assets in times of need, but they also offer some administrative relief for plan sponsors as well by relaxing some of the previous restrictions that could be easily overlooked.

By Chandler Julian, CPA, AIF

Chandler is a CPA and serves as the firm's Chief Financial Officer.

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