As the Plan Sponsor of a 401(k) Plan, there is a specific type of distribution your participants may be allowed to take that is called a hardship distribution. This type of distribution is only allowed if the participant has an immediate and heavy financial need that meets specific criteria.
The amount of the distribution is limited to the amount necessary to satisfy the financial need (this may include applicable federal, state or local taxes and also penalties that arise from the distribution) and is limited to the amount in specific portions of the participant account based on the timing of the distribution. Your Plan may allow these types of distributions but if they are allowed, it must be specified in the Plan Document. This distribution type is one of the few ways an existing employee can withdraw funds from the Plan while still employed.
There have been changes made to the general rules regarding hardship withdrawals.
For plan years prior to 2019, qualified matching contributions (QMAC’s), qualified non-elective matching contributions (QNEC’s), traditional safe harbor contributions and income earned on elective deferrals were not allowed to be used for a hardship withdrawal. This was changed as part of the Bipartisan Budget Act of 2018.
Another change as a result of the budget act was the removal of the requirement to suspend employee elective deferrals for six months after the hardship. Plans are required to eliminate the six-month suspension rule for any distribution made on or after January 1, 2020. Also, the requirement that a participant was to have taken all available plan participant loans before the distribution has been removed as a requirement. Plans may still require this per the Plan Document, but they are not required to include it.
The IRS has proposed regulations related to the budget act to add to the list of distributable events to include expenses and loss (including loss of income) related to a federally declared disaster as long as the employee’s principal address or principal place of employment is within a FEMA-declared disaster area. Lastly, the administrative procedures to be utilized by the Plan Sponsor to validate the need for the distribution have been modified.
The new proposed regulations state that for distributions made after January 1, 2020, the Plan Sponsor must:
(1) Ensure the distribution amount does not exceed the amount needed to satisfy the hardship.
(2) The employee must first use other available distribution methods (not including participant loans) if there are any and.
(3) May allow the employee to represent to the employer in a written form or via a recorded telephone conversation that the employee has insufficient cash or liquid assets to satisfy the financial need and, thus, proving the need for the financial hardship. The Plan Sponsor may rely upon the employee representation unless they have actual knowledge to the contrary.
Note that Plan amendments to reflect these hardship changes are required. The change must be made by the end of the second calendar year that begins after the issuance of the Required Amendment List that includes those changes. Interim amendments may be required to adopt provisions earlier.
The SECURE Act (Setting Every Community Up for Retirement Act signed into law on December 20, 2019, also made a change to the rules to allow parents to withdraw up to $5,000 from retirement accounts penalty-free within a year of birth or adoption for qualified expenses. The traditional 10% early withdrawal penalty does not apply to these distributions. You are also allowed to repay them as a rollover contribution back into your 401(k) plan.
These rules are subject to change by the IRS as some are part of proposed regulations. We recommend you review the IRS website for the most current information prior to making a plan change. You can use the link below to get started:
It is also a good idea to review the changes with your service provider or record-keeper as they will understand the workings of your Basic Plan Document which may impact some of the above items. We believe keeping up-to-date with these changes is important to ensure your Plan remains compliant and also to enable you to respond to the changing needs of your employees/participants.
Retirement plans can be very complex. As an innovative firm Summit CPA specializes in 401(k) audits. We have the ability to offer assistance entirely off-site with little or no distraction to your daily office routine. We also offer flat-fee pricing so there are no surprises on your bill when the job is complete. For assistance contact our office at (866) 497-9761 to schedule an appointment.