Some, but not all 401(k) Plans allow for a Hardship Distribution. The IRS has recently released their final regulations on this topic. In general, these new rules will simplify the process. You can use the new rules now, although your plan document will need to be amended in the near future. The purpose of this Bulletin is to briefly describe these new rules, and how we will help you to comply. If your plan does not allow for hardship withdrawals, this Bulletin doesn’t apply.
Q: Does the employee really need that much “hardship” money? Do I have to audit their finances to prove it?
A: No, but there are three steps that you need to take. First, the Employer must ensure that the amount of the hardship payout doesn’t exceed the hardship “need”. Second, the employee must take any available “non-hardship” payouts, such as in-service distributions, if they’re allowed, from the 401(k) plan. Finally, the employee must demonstrate that they have no other (personal) funds to pay for the hardship. On this last point, the Employer can now rely upon the employee’s representation that they have insufficient funds. (Exception: If the Employer knows that this representation is false, they can’t accept it.).
Q: Must the employee take a loan before they can receive a hardship payout?
A: No – this requirement has been eliminated.
Q: Must we suspend the employee for participating for 6 months?
A: This suspension has also been eliminated. The objective that Congress and the IRS are trying to accomplish is to simplify the hardship process, and you can see that these changes are helpful in that regard.
Q: Can all funds be accessed via a hardship distribution?
A: Previously, the employee could not take out either (a) investment earnings on their own elective deferrals, or (b) Safe Harbor employer contributions. Those restrictions have now been eliminated. While it is still an option as to what sources of funds can be made available in a hardship, we are going to assume that all funds (including employer contributions) will be made available. If you would like a more restrictive approach, please let us know, so that we can tailor your plan amendment (more on this below) appropriately. Otherwise, all vested accounts will be available upon hardship.
Q: Did the definition of a “hardship” change?
A: Nothing major, just some clarifications. As a reminder, the basic requirements for a “hardship” are unchanged:
- Medical expenses
- Purchase of a primary residence
- Preventing eviction or foreclosure
- Funeral expenses
- Casualty Damage causing home repairs – the change here is that you no longer need to live in a federal disaster area to claim this one. (This requirement only existed for a very short time.)
- Beneficiary expenses – Some of the hardship reasons and expenses listed above can be paid on behalf of a “primary beneficiary”. This includes medical, educational, and funeral expenses. This provision has been around for several years.
Q: Do we need to amend our plan document to reflect these new rules?
A: If your plan allows for a hardship distribution, then it will have to be amended. If we are responsible for your plan document, we’ll provide the amendment. Otherwise, you should ask your document-provider. It appears that the amendment deadline will be early 2021, and is based upon the Employer’s tax return deadline (including extensions) for their 2020 return. However, we intend to provide this amendment to you within the next 60 to 90 days.
In preparing this amendment, we’ll allow for the most “liberal” options available. (Examples – (a) Allow all vested funds to be paid out, including both employer and employee contributions. (b) Allow a payout for hardships for a primary beneficiary.)
Q: Are the rules the same for 403(b) Plans?
A: Almost. The main differences are that (a) (due to quirks in the law) investment earnings on elective deferrals can’t be paid out, and (b) certain “safe harbor contributions” also can’t be paid out.
Q: Finally, what should I do?
A: Be on the lookout for the plan amendment that we’ll be e-mailing to you shortly. Please let us know if you have any questions, or if you’d like to discuss these issues further. This seems to be a positive development for 401(k) Plans.
If you have any questions or concerns, please contact us at 412-847-7600