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.
- 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).
- 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.
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.
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