Congress passed a sweeping budget deal early on the morning of February 9th that will fund the government and waive the statutory debt limit. The bill also makes meaningful changes to the safe harbor rules governing hardship withdrawals from retirement plans.
The IRS has issued regulations governing hardship withdrawals from 401(k) plans. Since 2009, these regulations have also applied to 403(b) plans. Let’s take a high level look at the current regulations before looking at the changes made by the budget bill.
Hardship Distributions under IRS regulations
Under the IRS regulations, a hardship distribution may be made only for an immediate and heavy financial need – and only if other resources are not available to meet that need. Before a hardship distribution may be made, two tests must be met. The first focuses on events that qualify as a hardship and is often called the “Events Test”. The second focuses on whether the distribution is necessary to satisfy the financial need and is often referred to as the “Needs Test”.
The IRS regulations provide a “safe harbor” for each of the Events Test and the Needs Test. What’s that mean? If a plan follows the specific requirements of each safe harbor, then the plan is deemed to be in compliance with the regulations. If the plan makes its own determinations outside of the safe harbors, then it must be prepared to justify its decisions. Please remember that, where a plan has delegated administration of hardship distributions to TIAA as the plan’s record keeper, TIAA administers hardships only by following the safe harbors.
Events Test: Immediate and Heavy Financial Need
The IRS safe harbor regulations list six specific events that are deemed to satisfy the requirement that the hardship distribution be for an immediate and heavy financial need:
- Medical expenses (that are deductible) incurred by the employee, spouse, or dependents.
- Purchase of the employee’s principal residence.
- Payment of the next twelve months of post-secondary tuition and certain related costs for the employee, spouse, or dependents.
- Preventing eviction from the employee’s principal residence or foreclosure of a mortgage on the principal residence.
- Payments for burial or funeral expenses for the employee’s parent, spouse, child, or dependent.
- Expenses incurred as the result of certain casualty damage to the employee’s principal residence.
Needs Test: Distribution Must be Necessary to Satisfy Financial Need
Under the IRS safe harbor regulations, a distribution is deemed necessary to satisfy a financial need if certain requirements are met:
- The distribution must not be in excess of the need,
- All other distributions and loans must have been taken from all other employer plans, and
- Employee elective deferrals and employee contributions must be suspended for at least six months.
Changes Made by the Budget Bill
The budget bill potentially eliminates two of the requirements under the Needs Test. It directs the Treasury Department to make changes to the safe harbor regulations: (1) to delete the requirement that an employee take all available nontaxable loans prior to receiving a hardship distribution, and (2) to delete the six-month suspension of employee deferrals/contributions following the hardship distribution.
Prior to the passage of the budget bill, employee contributions might be withdrawn in the event of a financial hardship, but the earnings attributable to employee contributions could not be withdrawn. Under the bill, earnings on employee elective deferrals, qualified matching contributions (QMACs), and qualified non-elective contributions (QNECs) are all eligible for withdrawal upon financial hardship.
All of these provisions would apply to plan years beginning after December 31, 2018.
The budget bill directs that changes be made to the safe harbor regulations. Until we see draft regulations, it is difficult to know exactly what actions a plan sponsor may need to take to implement these changes. TIAA will track activity in this area and keep you fully informed.