Buried in Sections 41113 and 41114 of the recent Bipartisan Budget Act of 2018 are provisions designed to facilitate hardship withdrawals from 401(k) and 403(b) plans. Because these provisions take effect for plan years beginning after December 31, 2018, sponsors of these plans will want to consider whether to broaden their hardship withdrawal provisions – or even add such provisions.
Additional Amounts Eligible for Hardship Withdrawal
The only amounts currently eligible for hardship withdrawal are elective deferrals (both pre-tax and Roth). Earnings on such deferrals may not be withdrawn on account of financial hardship (other than earnings accrued before 1989). Nor may a hardship withdrawal provision be applied to special types of employer contributions known as “qualified non-elective contributions” (“QNECs”) or “qualified matching contributions” (“QMACs”).
All of these restrictions on hardship withdrawals will cease to apply as of the first plan year beginning after December 31, 2018. (Note that other types of employer contributions will continue to be subject to restrictions on in-service withdrawals – particularly contributions to money purchase pension plans.)
Elimination of Six-Month Suspension Requirement
Under current IRS guidance, any plan that wishes to take advantage of a regulatory safe harbor for hardship withdrawals must suspend a withdrawing employee’s elective deferrals for a period of six months following the withdrawal. This suspension requirement also applies to the employee’s after-tax contributions, and includes any employee contributions to other qualified and nonqualified plans, as well.
The Budget Act directs the IRS to remove this requirement from the regulations. Thus, an employee who obtains a hardship withdrawal could continue contributing to the plan. And from a plan administrator’s perspective, there would be no need to enforce the suspension requirement.
Coordination with Participant Loan Provisions
The current safe harbor also requires that a participant take all other available distributions before obtaining a hardship withdrawal. This requirement applies to participant loans, as well (to the extent a loan would not be taxable), and includes loans available under other qualified plans.
The Budget Act removes the requirement that a participant obtain all available loans before obtaining a hardship withdrawal. It does not remove the requirement that a participant first obtain all other available distributions. Thus, to the extent a plan makes other types of contributions available for in-service withdrawal without a showing of financial hardship, a plan administrator would have to continue applying this restriction.
Options for Employers
None of these changes are mandatory. And they won’t apply to a plan unless the plan is amended to reflect them. In deciding whether to adopt such an amendment, sponsors may want to consider the following:
- Retirement Readiness. One option for sponsors of 401(k) and 403(b) plans is to simply leave their current hardship withdrawal provisions in place. In fact, one could argue that facilitating such withdrawals is actually bad for participants – because it undermines their retirement readiness. Certainly, the requirement that participants take all available loans before obtaining a hardship withdrawal helps to safeguard their retirement assets.
On the other hand, allowing participants who obtain a hardship withdrawal to continue contributing to the plan would seem to improve retirement readiness. They could immediately begin replacing the assets that were withdrawn to satisfy the financial hardship. And unless a plan automatically reinstates a deferral election following the expiration of the six-month suspension period, there is always the risk that inertia will result in the participant effectively opting out of the plan for good.
- Administrative Simplification. Quite apart from what might be best for plan participants, sponsors and administrators of these plans may want to consider whether these new rules simplify plan administration. For instance, if a plan allows earnings to be withdrawn for financial hardship, there may be less need to track the amount of contributions versus earnings. The same could be true for QNECs and QMACs.
And eliminating the six-month suspension requirement should minimize the risks of operational noncompliance. At a minimum, this should help to shield the qualified status of a 401(k) plan.
At the same time, eliminating this suspension requirement could avoid a Code Section 409A violation resulting from the failure to suspend deferrals under a nonqualified deferred compensation arrangement in which the withdrawing employee also participates. Although the Section 409A regulations allow nonqualified deferrals to be suspended following a hardship withdrawal from a 401(k) plan, a nonqualified arrangement may need to be amended to deal with any elimination of this suspension requirement.
The bottom line is that sponsors of 401(k) and 403(b) plans will want to take some time to consider which, if any, of these new rules make sense for their workforce (and their administrative procedures). There will be advantages and disadvantages to any approach, so the sooner this review commences, the better the result is likely to be.