Update: IRS Issues Final Regulations Making Hardships Less Hard to Take

By Alex Mattingly and Kitso Malthape

In November of 2018, we wrote a blog post about the IRS’ proposed regulations regarding changes to the hardship distribution rules. On September 19, 2019, the IRS and Treasury Department issued the final regulations for hardship distributions rules. The final regulations are substantially similar to the proposed regulations, but clarify and slightly modify the proposed regulations. Plans that were amended to comply with the proposed regulations will be in compliance with the final regulations.

To recap, a hardship distribution is a distribution of funds from a 401(k) or 403(b) plan to a plan participant that is used to satisfy an immediate and heavy financial need and where the amount of the distribution does not exceed the amount necessary to satisfy that need. As in the proposed regulations, the final regulations eliminate the six-month suspension of elective deferrals for any participant that received a hardship withdrawal, expand the list of expenses that will be deemed to be the result of immediate and heavy financial need, increase the pool of funds that a participant may draw from for a financial hardship distribution, and streamline the process for employers to determine if the amount requested is in excess of the amount necessary to satisfy the immediate and heavy financial need by using a participant representation.

Most of the changes made by the final regulations are optional.  However, plan sponsors must eliminate the 6-month suspension of elective deferrals and begin requiring the new participant representation no later than January 1, 2020.  The January 1 deadline applies to all plans regardless of their actual plan year.

As in the proposed regulations, the final rules eliminate any duty on the plan sponsor to investigate whether a hardship withdrawal is necessary or not. Now, an employee must make a representation that he or she has insufficient cash or other liquid assets to satisfy the financial need for a hardship distribution.  The representation may be made in writing, by an electronic medium, or by telephone if the call is recorded.  While plan sponsors do not have an obligation to inquire into the financial condition of employees, if they have sufficiently accurate information contrary to an employee’s representation, then the financial need for a hardship distribution is not satisfied.

The final regulations permit plan sponsors to apply these changes to distributions made in plan years beginning after December 31, 2018. The prohibition on suspending an employee’s elective contributions and employee contributions as a condition of obtaining a hardship distribution may be applied as of the first day of the plan year beginning after December 31, 2018, even if the distribution was made in the prior plan year.  As stated above, suspension of deferrals must cease for hardships made after January 1, 2020, but the final regulations permit suspension of deferrals from hardships made in 2019 to extend into 2020 until the six-month suspension lapses.

The final regulations do differ from the proposed regulations in some ways. Both the proposed and final regulations require plan participant to make a representation that they do not have enough cash available to satisfy the necessary need with no plan sponsor inquiry or investigation required.  However, the final regulations allow the participant to make the representation even if they have enough cash on hand, provided that the assets are not reasonably available and are earmarked for payment of an obligation in the near future (e.g. utilities, car payment, or rent).

401(k) plans that permit hardship distributions will likely need to be amended to reflect these new rules by no later than December 31, 2021. However, plans must operationally comply with the new regulations as of Jan. 1, 2020.  The regulations provide that the amendment deadline for 403(b) plans is March 30, 2020.

If you have concerns about your plan’s compliance with the final regulations, please contact the Graydon Employee Benefits team, who will be happy to assist you.

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