The IRS issued final regulations on September 23, 2019, for hardship distributions from 401(k) plans. The final regulations are effective for distributions made on or after January 1, 2020, or the rules can electively be adopted for distributions made after December 31, 2018.
For a bit of background, 401(k) plans may include a provision that a plan participant can receive a distribution from the plan due to hardship. The participant must have an immediate and heavy financial need. There is a safe harbor listing of expenses provided by the IRS for which distributions are deemed made due to immediate and heavy financial need. These specified expenses include deductible medical expenses, costs to purchase a principal residence, higher education expenses, payments necessary to prevent eviction from or foreclosure on a principal residence, payments for burial or funeral expenses for immediate family, and expenses for the repair of a principal residence that would qualify for the casualty deduction.
Some of the expenses noted above may be exempt from the 10% penalty for early withdrawals for participants under age 59 ½. See our prior blog, “Exceptions to Early Withdrawal Penalty for 401(k) & IRA Distributions” for more detail. It is important to note that a hardship distribution could be subject to the 10% penalty if it does not meet one of the exceptions.
The final regulations issued on September 23, 2019, made the following changes relating to hardship distributions from 401(k) plans:
- The final regulations clarified that the change to the casualty deduction under the Tax Cuts and Job Act does not apply to hardship distributions. Therefore, a hardship distribution for damage to a principal residence is not limited to damage from a federally declared disaster.
- A new type of expense for certain disasters was added to the safe harbor listing of expenses for hardship distributions. Expenses and losses, including loss of income, incurred due to a disaster declared by the Federal Emergency Management Agency (“FEMA”) qualify for a hardship distribution if the participant’s principal residence or principal place of employment is located in an area for which FEMA is providing individual assistance for the disaster.
- The requirement to take a loan from the 401(k) plan prior to taking a hardship distribution is eliminated.
- The restriction that participants can’t make new contributions to the 401(k) plan within 6 months of the hardship distribution has been removed.
- There is a new standard to determine if a hardship distribution is necessary. Under this standard, all of the following conditions must be met:
- A hardship distribution may not exceed the amount of the participant’s financial needs. The distribution can include amounts for federal, state, and local income taxes or penalties resulting from the distribution.
- The participant must have taken other available non-hardship distributions under the employer’s qualified and nonqualified plans.
- The participant must provide a written representation that he or she has insufficient cash and no other liquid assets available to meet his or her financial need.
- There are expanded sources of hardship distributions from 401(k) plans, which can now be taken from contributions (elective, qualified non-elective, and qualified matching), and earnings on these amounts, regardless of when contributed or earned.
If you need guidance with determining your eligibility for a hardship distribution, you should contact your plan administrator and if you need further assistance contact The Tax Warriors® at Drucker & Scaccetti and we can discuss your options.