As part of the tax reform process, Congress proposed several changes to qualified retirement plans that were cut from the final bill. One of these proposals, making changes to the rules governing 401(k) hardship distributions, found a new home in the Bipartisan Budget Act of 2018, signed by the President on February 9, 2018 (the “Act”). The Act also made qualified retirement plan changes which provide additional relief to employees impacted by the California wildfires and who receive tax levy refunds.
Hardship Distribution Rules
Many 401(k) plans allow employees to take distributions of a portion of their account balance in certain hardship situations where the employee has an immediate and heavy financial need and the distribution is necessary to satisfy that need. Hardship determinations can be made in reliance on IRS “safe harbors” which are deemed to satisfy the requirements or based on the facts and circumstances.
Under the hardship distribution rules, eligible employees can take distributions of their own elective deferrals (but not any earnings) and, if permitted by the plan, certain employer matching contributions (excluding QMACs) and certain employer discretionary contributions (excluding QNECs). In addition, if a plan offers loans, employees are required to first take a loan before taking a hardship distribution and the current regulations generally prohibit employees from making voluntary contributions to the plan or like plans (including all qualified and nonqualified deferred compensation plans, ESPPs, etc.) for six months after taking a hardship distribution.
Effective for plan years beginning after December 31, 2018 (January 1, 2019 for calendar year plans) the Act permits employers to:
- Increase the sources from which a employee may take a hardship distribution to include vested QNEC and QMACs and earnings on employee deferrals.
Eliminate the plan loan requirements, allowing a participant to take hardship distribution without first taking a plan loan.
- Eliminate the requirement that an employee be suspended from making contributions to the plan or other like plan for six months following a hardship distribution, which will allow employees to continue their retirement savings uninterrupted. The Act instructs Treasury to modify the regulations that provide for the six month suspension and employers who are seeking to implement this change may want to wait to see if additional guidance is issued before year end. Employers removing the suspension should review the 401(k) plan and other like plans (e.g., account-based nonqualified deferred compensation plans, ESPPs, etc.) to determine what modifications are required (e.g., plan/policy amendments, coordination with payroll, the record-keepers, broker, etc.) and to decide whether to limit this change to the 401(k) plan or apply it to all like plans. Having a consistent policy will simplify administration and not having to implement the suspension may reduce operational failures under both the qualified and nonqualified deferred compensation (409A) plan rules. While an update to the SPD will not need to be provided for some time after the amendment, employers who decide to implement this change will need to update their distribution forms and clearly communicate the change to employees so that, if continuing contributions would be a hardship, the employee can stop making deferrals.
The hardship changes are optional and an employer may feel it is in employees’ best interests not to make some or all of these changes. For example, additional access to funds means more money may leave the plan and requiring a plan loan means that it is more likely that funds will be recontributed to the plan and can be used for retirement. However, since both the plan loan and six month suspension are part of the IRS “safe harbor,” deciding not to make theses change will impact hardship administration (e.g., the new relaxed IRS substantiation guidelines only applies to safe harbor hardship distributions). Therefore, employers who do not make these change need to decide if they are comfortable operating outside of the hardship safe harbors. Employers wishing to continue to rely on the safe harbors (as opposed to making individual hardship determinations) should plan to adopt these provisions.
Employers with employees in an area impacted by the California wildfires may amend their qualified retirement plans to let employees immediately take advantage of certain relief provided by the Act, including:
- Allowing certain “qualified individuals” whose place of abode was in a California wildfire disaster area between October 8, 2017 and December 31, 2017 and who sustained economic loss due the fires to take distributions of up to the lesser of their full vested account balance or $100,000. These distributions are exempt from the 10% early distribution penalty. Employees who take a qualified distribution may include this amount in income ratably over three years and receive “rollover” treatment if the amounts are repaid within three years.
- Increasing available loan amounts for loans made between February 9, 2018 and December 31, 2018. Generally a participant can only take a loan for the lesser of $50,000 or 50% of the vested value of the account. The Act increases the available loan amount for qualified individuals to the lesser of their full vested account balance or $100,000 reduced by the amount of any outstanding loans. Loan repayments that are due between October 8, 2017 and December 31, 2018 may be delayed for a year (although interest would accrue) and the repayment amount would be adjusted to take into account this delay and the accrued interest. Employers considering taking advantage of this relief should coordinate with payroll and their record-keeper to confirm the new limits and repayment delay can be administered.
Previously, if the IRS refunded an amount levied from a qualified requirement plan this amount could not be recontributed to the plan and therefore, these amounts were lost from the participant’s retirement savings. For plan years starting after December 31, 2017 (i.e., January 1, 2018 for calendar year plans) employers can permit the amounts returned to a participant (plus interest) to be recontributed/rolled over to an eligible retirement plan so long as certain timing requirements are met – generally by April 15 of the year after the amount is returned (i.e., by the due date, not including extensions, of the participant’s income tax return for the year in which the IRS returns the levy amount to the individual).
The changes under the Act are optional and, if an employer wishes to adopt some or all of the changes, the plan and SPD will need to be updated, as will various other notices / forms / communications. In addition, some of these changes will require coordination with other plans, payroll and the recordkeeper. Deciding to adopt the changes in the Act will allow employees more flexibility and may provide access to much-needed funds. However, since some of the changes impact an employee’s ability to withdraw additional funds from the plan (reducing the funds available in retirement) and will require additional administration, each employer should weigh the costs and benefits before implementing these changes.