It’s been a while, but we finally have them! Late last month, the IRS published the final hardship distribution regulations, nearly two years after Congress passed the Bipartisan Budget Act and the Tax Cuts and Jobs Act. The good news is that this final version follows the proposed version very closely. So closely in fact, that the IRS outright states in the final version that any plan that followed the proposed regulations will satisfy the final regulations.
If you’re familiar with the proposed version, you are ahead of the game. If you’d like to peruse our initial post from when the regulations were proposed, you can read it here.
The goal of the regulations is to make it easier for participants to access their plan accounts when they have experienced a true financial hardship, while simultaneously not interrupting their ability to continue to save for retirement – which is the entire purpose (get this) for a retirement plan. I know, it’s a complex concept.
Keeping the Deferrals Flowing
For plan years beginning in 2020, plans are no longer allowed to suspend employee deferral contributions as a result of a hardship distribution. The final regulations take that one step further and make it optional (though not mandatory) for non-qualified plans to retain the suspension or amend the plan to remove it – a point not mentioned in the proposed regulations.
As we approach the end of the 2019 calendar year, it is important to consider what you can do leading up to the point where the IRS puts a hard stop on all such suspensions.
Your options for 2019 are:
- Continue to apply the suspension through the end of the 2019 plan year for all hardship distributions taken;
- Eliminate the suspension for any future hardship taken during the 2019 plan year; or
- If participants have already taken hardships during 2019 and you have suspended their deferrals, cut the suspension short and resume deferrals.
Whatever your decision, you must be consistent. You should also document it so that it can be incorporated in the eventual plan amendment.
Modifying the Immediate & Heavy Financial Need
The final regulations made no change to the proposed modification for the safe harbor list of expenses. Those changes are outlined below:
- The “primary beneficiary under the plan” has been added as a qualified individual for whom medical, educational, and funeral expenses may be incurred;
- A hardship can now be taken in the event of a casualty loss that is tax deductible, regardless of whether that loss occurred in a federally-declared disaster area; and finally
- A seventh item was added to allow for expenses resulting from a federally-declared disaster to be taken as a hardship.
The IRS did clarify that the intent is to make expenses related to certain disasters (e.g. hurricanes, floods, wildfires, etc.) safe harbor items, thereby eliminating any delays waiting for the official announcement declaring the emergency – which we all know is not as quick a process as we might prefer. Again, the common theme throughout the regulations is easy access to retirement funds in a time of true financial need. One point worth noting, however, is that unlike previous disaster relief, these new regulations do not allow hardship distributions as a result of a participant’s relatives or dependents incurring disaster-related expenses. It is now limited only those expenses incurred by a participant who either lives or works in the disaster area.
Single Standard for Determining Necessity
The final regulations adopt the single standard in the proposed regulations, which completely eliminated the subjectivity of the facts and circumstances review, in order to apply a more objective standard. The objective review is broken into three requirements:
- The hardship distribution cannot exceed the amount of the financial need (including any amount necessary to pay any taxes or penalties reasonably expected to result from the distribution).
- The participant must have taken all available distributions from the plan or other plans sponsored by the employer, though taking a loan first is no longer required.
- The employee does not have other sufficient cash or liquid assets to satisfy the need. Plan sponsors can rely on an employee’s representation to that effect unless there is actual knowledge to the contrary.
The proposed regulations outlined that an employee may provide their representation either in writing, via electronic medium, or in any other form prescribed by the administrator. The final regulations adopt this language and go one further by noting that a verbal representation (e.g. a phone call) is also acceptable, if that conversation is recorded.
Additionally, if the administrator has any knowledge contradicting a participant’s representation, they should deny the request. That said, the plan sponsor can reference the information already on hand instead of having to question the veracity of the employee.
Expanding the Availability
Just as with the proposed version, the final regulations open the availability of all sources for hardship distribution purposes. This includes elective deferrals, QNECs, QMACs, and the earnings on these sources – regardless of when those contributions occurred. The IRS further clarified that safe harbor contributions made to a plan are considered either QNECs or QMACs and are, therefore, available for hardship. This is merely a discretionary change and not something you are required to implement.
The final version of the regulations, as with the proposed version, makes no mention of the earnings related to 403(b) deferrals. Therefore, such earnings remain ineligible for hardship distribution. Additionally, QNECs and QMACs are not eligible for hardship distribution if those funds are held in a custodial account. Outside of those two items, all of the new hardship rules also apply to 403(b) plans.
It's Time to Amend
There are only two parts of these rules that are mandatory to implement – removal of the suspension of deferrals post hardship distribution and the modification to the list of safe harbor expenses. Everything else is optional. That means an amendment is required to implement the mandatory changes and to document whether or not the optional changes will be implemented. That means it is critically important to keep track of which, if any, of the new rules have been applied in operation. To assist you in documenting these items, we have prepared a one-page sample administrative procedure that you can download here. If you would like assistance preparing the policy, give us a call and we are glad to help.
We can hear the question already: “That’s all fine and dandy, but when do I have to do this?” First, the easy part of the answer. The deadline to adopt the amendment is the due date of your tax return (with extensions) for the first tax year in which the new provisions are first implemented. For many companies, that translates to either the Spring or Fall of 2021. However, there are some open questions as to the exact deadline for companies that operate on a non-calendar tax year as well as those that implemented the new provisions prior to 2020. The American Retiement Association (an industry advocacy non-profit in which many from DWC are involved) has submitted a request to the IRS to clarify how the amendment deadline applies in those situations. We are following this closely and will communicate any updates as we have them.
We anticipate that the plan amendment language will be available sometime this Fall, and we will be in touch with all of our clients about the amendment process as soon as possible after we have had an opportunity to review it. If you have any questions in the meantime, you know where to find us!