Most sponsors of Section 401(k) plans are familiar with the standards for allowing active employees to withdraw their elective deferrals on account of “financial hardship.” The same hardship withdrawal standards apply to Section 403(b) deferrals. However, far more stringent in-service withdrawal standards apply to nonqualified deferred compensation arrangements that are subject to Code Section 409A. These “unforeseeable emergency” standards apply to Section 457(b) plans, as well. In its Revenue Ruling 2010-27, the IRS has helped to define the scope of these unforeseeable emergency standards.
Actually, this is an area in which the IRS has long had guidance. Regulations issued under Section 457 spelled out specific standards for allowing in-service withdrawals due to unforeseeable emergencies. Those standards were then incorporated into a model amendment issued as part of Revenue Procedure 2004-56. According to this latest guidance, Section 5.10 of that model amendment provides for “unforeseeable emergency” withdrawals in all of the circumstances permitted under the Section 457 regulations.
In general, the standard for allowing a withdrawal on account of a participant’s unforeseeable emergency requires that the participant experience a severe financial hardship due to one of the following events:
- An illness or accident of the participant, the participant’s spouse, or the participant’s tax dependent;
- The loss of the participant’s property due to casualty;
- The need to pay for funeral expenses of the participant’s spouse or tax dependent; or
- Other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the participant.”
The highlighted phrase prompts the most questions in this area. That is, how “similar” must the circumstances be to any of the listed events in order to allow an active employee to obtain an in-service withdrawal from either a 457(b) plan or a nonqualified deferred compensation arrangement?
Both the regulations and the model amendment list examples of circumstances that are deemed to be “similar” for this purpose. These include the imminent foreclosure on, or eviction from, a participant’s primary residence, or the need to pay for medical expenses, including non-refunded deductibles, and the cost of prescription medications. The examples specifically rule out withdrawals to purchase a home or to pay college tuition, on the ground that these events are not “unforeseeable.”
The latest guidance makes clear, however, that these examples are not intended to be exhaustive. Rather, other factual circumstances may be sufficiently “similar” to the listed events to constitute an unforeseeable emergency. Based on the factual scenarios outlined in Revenue Ruling 2010-27, such circumstances might include the following:
- The need to repair a participant’s principal residence due to significant water damage (assuming this damage is not covered by insurance and arises as a result of events beyond the participant’s control), even though the damage may not be the result of a natural disaster; or
- The need to pay for the funeral expenses of a participant’s adult child, even though the child is no longer a tax dependent of the participant.
On the other hand, this latest guidance also makes clear that certain circumstances do not constitute an unforeseeable emergency for this purpose. The example given in the Ruling involves a participant who requests an unforeseeable emergency withdrawal to pay accumulated credit card debt. Because that debt was not itself due to any circumstances that were extraordinary and unforeseeable and that arose as a result of events beyond the participant’s control, the IRS ruled that an in-service withdrawal could not be allowed. In other words, the IRS looks to the nature of the event that gave rise to the credit card debt, and not the fact that the accumulated debt may now be so large as to constitute an emergency from the participant’s standpoint.
The upshot of this latest guidance is that any plan sponsor who is faced with a request for an unforeseeable emergency withdrawal should ask for proper documentation of the underlying debt. Absent such documentation, the request for a withdrawal should be denied.