On September 23, 2019, the IRS and Department of the Treasury published final regulations regarding hardship distributions for certain qualified retirement plans, including 401(k) and 403(b) plans.

The final regulations generally mirror the proposed regulations issued by the IRS and Treasury in late 2018.

This update provides a brief summary of key changes to the hardship rules and a list of effective dates and action items for plan sponsors.

Key changes to the hardship rules

Elimination of six-month suspension

Effective January 1, 2020, plans may no longer impose a six-month suspension on participants who take hardship distributions. Although elimination of the six-month suspension is not required until January 1, 2020, plan sponsors may eliminate the suspension earlier than that date.

Note: this rule does not apply to plans subject to Code section 409A (unfunded nonqualified deferred compensation plans). Plan sponsors of nonqualified deferred compensation plans may retain their suspension provisions, but should evaluate the continued maintenance of any plan provision that automatically cancels a deferral election upon the participant's hardship distribution under a qualified retirement plan.

Employee representation

Effective January 1, 2020, an employee must represent to the plan administrator that the employee has insufficient cash or other liquid assets reasonably available to satisfy the financial need, and the plan administrator cannot have contrary knowledge. The representation may be in writing, by electronic medium, or by verbal representation via telephone if the call is recorded.

Loan requirement

A plan can still require a participant to take all available loans before a hardship distribution, but that is no longer mandatory. There remains a general requirement that participants take all other withdrawals and currently available distributions (including distributions of ESOP dividends) from all other qualified and nonqualified plans.

Expanded amounts eligible for distribution

Plans may now allow hardship distributions to be taken from elective contributions, qualified nonelective contributions, qualified matching contributions, and earnings on these amounts, regardless of when contributed or earned.

Damage to principal residence

The Tax Cuts and Jobs Act of 2017 restricted the casualty loss deduction to losses attributable to a federally declared disaster. The final regulations clarify that, for purposes of hardship distributions under a qualified retirement plan, the restriction that the loss be attributable to a federally declared disaster does not apply.

Expansion of safe harbor hardship expenses

The final regulations add to the list of safe harbor hardship expenses any expenses or losses (including loss of income) incurred as a result of a federally declared disaster that occurs in the area of the employee's principal residence or principal place of employment. This is similar to (but narrower than) the IRS's past practice of granting relief from hardship distributions following natural disasters, and will require a plan amendment.

Requirements and timing issues

Most of the above-described changes are optional. The only mandate is that plans must eliminate the six-month suspension period and begin requiring participant representations no later than January 1, 2020. This deadline applies whether or not a plan year coincides with the calendar year.

Although operational changes are required sooner, the deadline for amending individually designed plans to comply with the final regulations is not required until December 31, 2021 (or a later deadline may apply if the IRS delays the inclusion of these final regulations in its 2019 Required Amendments List).

The Treasury Department and IRS have extended the deadline for adopting an amendment for a pre-approved plan to the 2020 tax-filing deadline plus extensions.

Action items for plan sponsors

Plan sponsors should review their plans to ensure they comply in operation with the final regulations in order to maintain the plans' tax-qualified status.

For more information or assistance, please contact the authors. Learn more about our Employee Benefits and Executive Compensation group here.