IRS Guidance

Washington Pulse: New Rules Will Govern Retirement Plan Hardship Distributions

The Treasury Department has released proposed rules which—if finalized in present form—will significantly ease access to retirement plan assets for participants who experience financial hardship. The changes are a direct result of the Bipartisan Budget Act of 2018 (BBA), enacted in February of this year.

Treasury also took this opportunity to propose related changes that stem from several other laws previously enacted and related guidance. Like most proposed regulations, these are subject to a public comment period, and the potential for a public hearing. It’s generally hoped that they will be adopted with little—if any—change, since some of the provisions included in the regulations are or will be effective before the close of the 60-day comment period that will end January 14, 2019.

 

The Role of Hardship Distributions

Participants may generally access their retirement assets only after a specified event or events occur (e.g., separation form service, attainment of normal retirement age). Distributions due to hardship are also available in many plans, and are intended to serve as a last resort resource for participants who experience difficult financial circumstances.

 

How is the Need for a Hardship Distribution Now Determined? 

Two conditions must be met. First, there must be “immediate and heavy financial need.”  Second, a distribution from the plan must be considered necessary to satisfy that financial need.

Determining financial need can currently be based on “all relevant facts and circumstances.” An option—one intended to simplify this determination for plan administrators, and actually used by most plans—makes use of six “safe harbor” expense reasons, any one of which will be deemed to meet the condition of “immediate and heavy financial need.”  These currently include medical care, principal residence purchase, education expense, preventing eviction or foreclosure, funeral expense, and repair of damage to a principal residence.

In addition, it must be determined that a hardship distribution is necessary to meet this need. Current rules require that the amount distributed not exceed the actual need, and that there are no alternative financial resources outside of the plan available to satisfy that need. The determination of whether the need can be satisfied with non-plan resources currently can be based on “all relevant facts and circumstances.”  To satisfy this facts-and-circumstances condition, an employer is permitted to rely on an employee’s “representation” that the need cannot be met with other financial resources, unless the employer “has actual knowledge to the contrary.”

There is also a safe harbor for determining the necessity of the hardship distribution. If the employee has taken all available plan distributions and loans, and is required to cease making deferrals and employee contributions to the plan for at least six months, then a hardship distribution can be “deemed necessary to meet immediate and heavy financial need.”

To sum up, if a hardship distribution is sought for one of the six above-described safe harbor reasons, and a need for the distribution is established either by facts-and-circumstances or by safe harbor means, then granting a hardship distribution will generally be considered justified.

 

How are the Rules Changing?

BBA made significant statutory changes relative to hardship distributions, both broadening the employee account types available, and eliminating the requirement that available plan loans be taken before granting a hardship distribution. BBA also directed the Treasury Department to make specific revisions to existing regulations governing these distributions. In general, with some exceptions, they are to be effective beginning in 2019 plan years. Together, BBA and the proposed regulations would yield the following important changes.

  • Balances in an employee’s account in addition to employee deferrals may now be distributed for hardship reasons, including qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), employer ADP safe harbor and QACA safe harbor contributions, and earnings on all these amounts; plans may, but will not be required, to include these amounts in hardship distributions; effective for 2019 plan years.
  • Available plan loans need not be taken before seeking a hardship distribution, but whether to impose the requirement will remain a plan option.
  • There is no longer a requirement to suspend employee deferrals and employee contributions for at least six months; all plans must conform to this change (this will also apply to qualified reservist distributions).

 

Clarifications, Timing of the Proposed Changes

The BBA statutory change and directive to the Treasury Department for regulations revisions raised questions as well as providing answers. Following are some much-awaited clarifications, as well as timing details.

 

Suspension of Employee Deferrals for Hardship Recipients

  • As of the first day of 2019 plan years, a suspension of employee deferrals and employee contributions is not required when granting a hardship distribution; this must take effect for distributions on, or after, 1/1/2020.
  • In transition, participants whose employee deferrals and employee contributions are under a six-month suspension can resume deferring as early as the start of 2019 plan years, even if that results in a shortened suspension period; this will be a plan option, the IRS granting a transition period leading up to the mandatory change January 1, 2020, in recognition of the timing of these regulations’ release.

 

Provisions Related to “Deemed Immediate and Heavy Financial Need” Safe Harbors

To simplify determining whether a participant or beneficiary has an “immediate and heavy financial need,” regulations identify six “safe harbor” expenses that satisfy this condition. These proposed regulations add a seventh qualifying expense, and contain the following clarifications and revisions.

  • Federal disaster declarations: this provision would add a new safe harbor to the existing six safe harbors described previously, for “expenses and losses—including loss of income—incurred by the employee” in FEMA-declared disasters; effective for distributions on, or after, January 1, 2018.
  • Repair of damage of principal residence: the Tax Cuts and Jobs Act of 2017 (TCJA) eliminated an income tax deduction for certain personal casualty losses for tax years 2018 through 2025, except in the case of disasters declared by the Federal Emergency Management Agency (FEMA). One of the six current hardship distribution safe harbors is for repairing damage to a principal residence. Due to its dependence on the TCJA-eliminated tax code provision, this safe harbor would have been unavailable during these years, except in the case of FEMA-declared disasters. These regulations propose to retain the principal residence repair safe harbor reason uninterrupted, declaring the TCJA provision inapplicable in the case of hardship distributions.
  • Primary beneficiary safe harbor: this change would align the regulations with an earlier law change that—plan permitting—includes the hardship of an employee’s primary beneficiary—for medical, educational or funeral expenses—whether or not that is the employee’s spouse; effective for distributions on, or after, August 17, 2006.

 

A Simpler Standard for “Distribution Necessary to Satisfy a Financial Need”

In addition to the requirement that there be an “immediate and heavy financial need,” a hardship distribution must be found “necessary to satisfy…” that financial need. Currently, satisfying this second requirement can be “…based on all the relevant facts and circumstances…”—a potentially challenging determination—or under a safe harbor that requires suspension of employee deferrals and employee contributions, and taking available plan loans.

  • The regulations propose “one general standard” to determine that a hardship distribution is “necessary to satisfy financial need.” To satisfy this standard—which is optional for 2019 plan years, mandated as of January 1, 2020—employers will no longer be required to suspend employee deferrals and employee contributions or have employees take available loans.
  1. Under this single standard, a hardship distribution must not exceed an employee’s need, other available plan distributions must have been taken, and “the employee must represent that he has insufficient cash or other liquid assets to satisfy the financial need.” (Current regulations anticipate a participant potentially being required to liquidate an illiquid asset, such as property).
  2. Currently, a plan administrator may rely solely on such employee representations “unless the plan administrator has actual knowledge to the contrary.” Going forward—effective January 1, 2020—a plan administrator must obtain such representation.
  • In transition, the above-described employee representation is not required for hardship distributions before January 1, 2020 (this delay is described as being due to the timing of these proposed regulations).

Limitations to the Expanded Account Sources Eligible for Hardship Distribution

Before BBA, employee elective deferrals—but not QNECs, QMACs, employer safe harbor 401(k) contributions—or their earnings—were eligible for hardship distribution. (The only exception was for certain pre-1989 amounts.)  While BBA expanded the funds eligible for hardship distribution, not all impacts were initially clear.

  • While hardship distributions may—for 2019 and later plan years—include these account sources, this is proposed as a plan option, not a requirement.
  • Unexpectedly, the broadening of hardship-eligible accounts appears to include the 401(k) safe harbor plan design known as qualified automatic contribution arrangement, or QACA, in which employer contributions may require a vesting period; such unvested amounts—of course—may not be distributed.
  • While earnings in 401(k) plans may be included in hardship distributions, this is not true of 403(b) plans, because BBA did not modify an equivalent 403(b)-governing statute.
  • QNECs and QMACs in annuity-based 403(b) accounts can be distributed due to hardship, while those in 403(b)(7) custodial accounts cannot.

 

Special Relief for Hurricanes Florence and Michael

In addition to the ongoing relief in federally-declared disaster situations already described, these proposed regulations would offer “expedited access to plan funds” for victims of 2018 Hurricanes Florence and Michael. Relief similar to that in IRS Announcement 2017-15—regarding California wildfires—is being provided.

  • A plan may add a hardship distribution feature after the fact (by retroactive amendment), and will have temporary relief from having to follow normal hardship administrative procedures.
  • Plan administrators must, however, make a good-faith effort to comply with administrative procedures, and as soon as practicable’ obtain required documentation.
  • Timing for relief eligibility is determined by the variable, FEMA-specified dates for the areas of the country affected by these identified hurricanes.
  • Procedural relief is provided through March 15, 2019, and plans must be amended for any specially-granted hurricane-related relief no later than the timing to amend for these proposed hardship regulations.

 

Plan Amending

While it is possible—if unlikely—that some provisions or their effective dates could change as a result of public comments, what is known for certain is that all plans offering hardship distributions will have to be amended. Deadlines will differ depending on whether a plan uses a pre-approved document or an individual-designed document (IDD). Pre-approved plan amending will be tied to either the sponsor’s plan year or taxable year—the year the amendment is adopted or effective—and IDDs will amend by a deadline tied to IRS issuance of its Required Amendments list.

 

How Will the Industry Respond?

Perhaps the question could just as readily be “How has the industry responded?  Given the 2019 plan year effective date for BBA’s provisions on hardship distributions, administrative decisions had to be made, even without available guidance. These decisions had potential impacts on system programming, employee communications, and other dimensions of plan administration. For example, would employers be given the option to continue requiring the current six-month suspension of employee deferrals after granting a hardship distribution, or would this be eliminated completely?

This is but one example, added to which is the fact that some elements of the proposed regulations were entirely unanticipated. The inclusion of QACA contributions as an account type eligible for hardship distribution was generally not expected. And there was the question of how 403(b) plans should be handled compared to 401(k) plans.  Most of these and other answers are now known, though perhaps belatedly. Going forward, those who administer the plans affected by these regulations at least have a road map. Hopefully there will not be any significant detours on the road from these proposed regulations to the final guidance.

 

Ascensus will continue to monitor the status of these regulations, and the industry’s response to them. Visit ascensus.com for the latest developments.

 

Click here for a printable version.


IRS Issues Proposed Amendments to Retirement Plan Hardship Rules

The IRS released proposed amendments in REG-107813-18 to defined contribution retirement plan hardship distribution regulations. These amendments have been drafted to reflect statutory changes contained in the Bipartisan Budget Act of 2018 and the application of hardship rules related to modifications made by the Tax Cuts and Jobs Act.

While the summary introducing these proposed amendments specifically identifies 401(k) plans, it further notes that these amendments “would affect participants in, and beneficiaries of, employers maintaining, and administrators of, plans that contain cash-or-deferred-arrangements, or provide for employee or matching contributions.” This would also include certain 403(b) plans.

The general categories identified in the proposed regulation for changes include the following.

  • Deemed Immediate and Heavy Financial Need
  • Distribution Necessary to Satisfy Financial Need
  • Expanded Sources for Hardship Distributions
  • Relief for Victims of Hurricanes Florence and Michael

The IRS is providing a 60-day comment period as described in the proposed regulation document.

 

Watch ascensus.com news for additional developments.


Hurricane Michael Disaster Relief Expanded to More Counties in Florida, Georgia

The IRS has added more Florida counties to those initially identified as eligible for tax-related deadline relief in the wake of Hurricane Michael.  Newly added is similar relief for identified counties in Georgia.

IRS News Releases FL-2018-04 and GA-2018-04 describe the relief provided in Treasury Regulation 301.7508A-1(c)(1) that applies to various tax-related acts whose deadlines can be extended by a disaster declaration. These include, for example, completion of rollovers or recharacterizations, correction of certain excess contributions, making plan loan payments, filing Form 5500, and certain other acts under the above-described regulation.

See the news releases for the counties that currently are included in the tax-deadline relief. The IRS often updates the disaster news releases for new counties that get added to the relief. The IRS has indicated that if the Hurricane Michael disaster declaration is further broadened by the Federal Emergency Management Agency (FEMA) to include other areas, the same relief will apply there.

For those covered by the Florida guidance, covered tax-related deadlines that fall on or after October 7, 2018, and before February 28, 2019, are extended to February 28, 2019.  In Georgia, deadlines that fall on or after October 9, 2018, and before February 28, 2019, are extended to February 28, 2019.

The automatic relief applies to residents of the identified areas, to those whose businesses or records necessary to meet a covered deadline are located there, and to certain relief workers providing assistance following the disaster events. Any individual visiting a covered disaster area that is injured or killed as a result of the events is also entitled to deadline relief. Affected taxpayers who reside or have a business located outside the covered disaster areas are required to call the IRS disaster hotline at 1-866-562-5227 to request relief.


IRS Issues Proposed Rules on Safe Harbor De Minimis Reporting Errors

The IRS has issued proposed regulations on a safe harbor for relatively minor—de minimis—errors in providing certain information returns filed with the IRS and payee statements provided to taxpayers.

These returns and statements, which include such IRS forms as 1099-R, 5498, and others in these series, report information on such tax-advantaged savings arrangements as IRAs, employer-sponsored retirement plans, Coverdell education savings accounts (ESAs), and 529 plans.

Penalties can be assessed against custodians, trustees, or issuers for failure to timely file correct information returns or payee statements, unless reasonable cause can be shown. However, the Protecting Americans from Tax Hikes (PATH) Act of 2015 created an exception to certain of these penalties when the reporting errors are within stated tolerances; examples include dollar amount errors that do not exceed $100, or when income tax withholding amount errors do not exceed $25.

The IRS is asking for public comments on all aspects of the proposed regulations. Details on comment submissions can be found in the Addresses section of the proposed regulations.


IRS Releases Updated Retirement Plan Correction Guidance

The IRS has released Revenue Procedure 2018-52, which is the IRS’ Employee Plans Compliance Resolution System (EPCRS) guidance that now modifies and supersedes the former guidance in Revenue Procedure 2016-51. EPCRS is a system of corrective programs created by the IRS to assist in correcting certain compliance issues for retirement plans.

Revenue Procedure 2018-52 outlines EPCRS procedures. A notable change to this new revenue procedure is that as of April 1, 2019, the IRS will no longer accept paper submissions for the Voluntary Correction Program (VCP) or process user fees paid with a paper check. Plan sponsors wishing to submit through VCP after that date will need to use pay.gov to file VCP submissions and pay user fees.

Revenue Procedure 2018-52 is effective as of January 1, 2019, but allows for a transition period where paper VCP submissions can still be made from January 1, 2019, to April 1, 2019.


IRS Issues Guidance on New UBTI Calculation With Potential Effects on IRAs and Other Tax-Advantaged Savings Arrangements

The IRS has issued Notice 2018-67 that describes a change in the calculation and reporting of unrelated-business taxable income (UBTI). This change is a consequence of the Tax Cuts and Jobs Act, tax reform legislation enacted in 2017.

The impact on IRAs and other tax-advantaged savings accounts is likely to be limited because only those accounts that have an ownership interest in a revenue-generating business enterprise are subject to current-year taxation of that income as UBTI.

Prior to the tax law change, taxable current-year earnings and losses from multiple UBTI-generating businesses could be “netted,” meaning earnings from one business could be offset with losses from another includable business. In general, if the net UBTI was less than the $1,000 reporting threshold, no filing was required of Form 990-T, Exempt Organization Business Income Tax Return. The change in effect for 2018 and future taxable years requires that UBTI be reported when taxable business earnings reach $1,000, but is not offset by net losses of one or more UBTI-generating lines of business—in this case, UBTI-generating business interests held within an IRA or other tax-advantaged account.

Note however, that only such accounts that hold interests in multiple businesses generating UBTI would potentially be affected.  Such business interests are among the less common IRA or other tax-advantaged account investments, and generally are held in such accounts administered by nonbank trustees or by trust departments.


IRS Extends Temporary Nondiscrimination Relief for Closed Defined Benefit Pension Plans

The IRS this week released Notice 2018-69, Extension of Temporary Nondiscrimination Relief for Closed Defined Benefit Plans Through 2019. This guidance extends relief granted to certain defined benefit (DB) pension plans that was set to expire at the end of 2018 plan years.

Certain DB plans that continue to accrue benefits for existing participants, but are closed to the entry of new participants, could otherwise face nondiscrimination failures if not for this relief. The situation commonly involves sponsoring organizations that are enrolling new eligible employees in a defined contribution plan, but allowing existing DB plan participants to continue to accrue those benefits.

The nondiscrimination relief is available for plan years beginning before 2020 if conditions outlined in Notice 2014-5 are satisfied. The IRS notes that this extension is provided in anticipation of the issuance of final amendments to the IRC Section 401(a)(4) regulations.


IRS PLR Addresses Retirement Plan Contributions Tied to Student Loan Repayment

The IRS has issued private letter ruling (PLR) 201833012, responding to a request for a ruling on a proposed employer 401(k) plan feature to be associated with employees’ student loan repayments. After review, the IRS approved the request and added explanation of why the facts as presented will not violate retirement plan laws and regulations. While this is a private letter ruling to be relied upon by the requestor, it is not a new concept as it has been proposed in at least one federal bill introduced by a member of Congress and has been a subject of discussion within the retirement plan industry.

PLR Request

Under the 401(k) plan of the employer on whose behalf the PLR application was submitted, matching contributions are now received by those participating employees who defer their salary into the plan. The PLR request proposes to amend the plan to add an element tied to student loan repayment. Under the arrangement proposed, if an employee affirmatively elects to participate in the employer’s student loan benefit program, and during a pay period makes a student loan repayment equal to at least 2 percent of his compensation, the employer would make a “student loan repayment nonelective contribution” of 5 percent of that pay period’s compensation to the employee’s 401(k) plan account.

This nonelective contribution formula, incidentally, is identical to the plan’s matching contribution formula for those employees who defer their salary into the 401(k) plan. That is, all eligible employees who defer at a rate of at least 2 percent earn a “matching contribution” of 5 percent.  Furthermore, it would not be an either/or situation. An employee who participates in the student loan benefit program could simultaneously defer salary into the 401(k) plan, and if deferring at least 2 percent, also earn the plan’s 5 percent matching contribution.

The PLR notes that under the proposal the student loan repayment nonelective contribution would be “subject to all the applicable plan qualification requirements, including, but not limited to, eligibility, vesting, and distribution rules, contribution limits, and coverage and nondiscrimination testing.”

IRS Position

The IRS specifically notes that the employer’s contribution under the student loan repayment program will not be treated as a matching contribution, thereby avoiding conflict with the “contingent benefit prohibition” of 401(k) plans. If the employer’s contribution associated with the student loan benefit program were to be considered a matching contribution received for an employee’s action outside the scope of the plan, such as making student loan repayments, the rule would be violated. Though it may seem only a semantic distinction, the fact that the benefit would be considered a nonelective contribution rather than a matching contribution is what led to the IRS to approve this PLR submission.

A plan contribution such as that proposed in this PLR might not be available in every plan document, and even with a document that would allow a special allocation approach such as described here, it bears repeating the PLR’s emphasis that all applicable plan qualification requirements must be met.

Note that a PLR may only be relied upon by the party to whom it is issued, though it generally is recognized that a PLR may reflect IRS policy and ruling inclinations for similar or identical fact patterns.


IRS Extends DC Plan Restatement Submission Period by 3 Months

The IRS has issued Revenue Procedure 2018-42, announcing a three-month extension in the submission period for opinion letters for pre-approved defined contribution (DC) retirement plans.

The submission period for on-cycle submissions in this remedial amendment cycle (the third six-year remedial amendment cycle) was scheduled to expire October 1, 2018. Revenue Procedure 2018-42 now extends that submission period through December 31, 2018.

This remedial amendment cycle combines the formerly separate master and prototype and volume-submitter programs into a single unified opinion letter program.


IRS Issues Final Regulations Approving Forfeitures to Fund QNECs, QMACs

The IRS and Department of the Treasury have issued final regulations amending the definitions of qualified nonelective contribution (QNEC) and qualified matching contribution (QMAC), settling the issue of whether participant forfeitures can be used to fund QNECs and QMACs.

QNECs and QMACs are types of employer contributions to qualified retirement plans commonly used to correct certain contribution testing failures in 401(k)-type plans. Unless certain safe harbor exemptions apply, 401(k) plans generally must satisfy rules that limit the disparity between the average deferrals of highly compensated employees (HCEs) and nonhighly compensated employees (nonHCEs). Similarly, in nonsafe harbor situations, 401(k) plans must satisfy rules that limit the disparity between average matching contributions of HCEs and nonHCEs. To correct testing failures under these rules, employers can make QNECs and QMACs.

These final regulations finalize the proposed regulations issued by the IRS in January 2017, which first altered the definitions of QNEC and QMAC to allow the use of forfeitures in funding QNEC and QMAC contributions. Before 2017, the IRS and Treasury Department interpreted the 401(k) regulations in a manner that did not permit the use of participant forfeitures to fund these employer contributions.

The final regulations are scheduled to be published as early as July 20 in the Federal Register, and will take effect on that publication date.