Need Some Cash? Congress Just Made It Easier to Withdraw Retirement Account Money



Buried in the new law that will keep the government running for another two years is a set of changes affecting hardship withdrawals from 401(k) accounts and other retirement plans.

While the changes should make it easier for employees to access funds in their retirement accounts when they have pressing financial needs, retirement plan sponsors will need to reexamine hardship distribution options under their plans before the changes take effect in 2019.

To gain further insights on how provisions in the Bipartisan Budget Act of 2018 (Pub. L. No. 115-123) will affect hardship distributions, Bloomberg Law talked to Rosie Zaklad, a principal at the Groom Law Group whose practice involves retirement plan design and compliance.

Bloomberg Law: What are the main changes to hardship distributions as a result of the new budget law?

Rosie Zaklad: The 2018 budget law eased hardship withdrawal rules by:

  • expanding hardship distribution fund sources;

  • allowing hardship withdrawals without first taking a plan loan; and

  • eliminating the six-month suspension on retirement plan contributions following a hardship withdrawal.

Note, some people (including lawmakers) may not have been aware of the change to the hardship distribution rules in the Tax Cuts and Jobs Act of 2017 due to the change to the casualty loss deduction.

BL: In what ways did the budget law expand the sources available for a hardship distribution, and what is the impact on plan participants and sponsors?

Zaklad: Starting in 2019, participants who need quick access to additional funds will be able to tap into investment earnings, qualified matching contributions, qualified nonelective contributions, and safe harbor contributions for hardship distributions. From a plan sponsor and recordkeeper perspective, it’s a much-needed simplification. Starting in 2019, there should be no need to track earnings separately from pre-tax contributions.

It also eliminates one disadvantage of offering a safe harbor plan, which is a type of 401(k) plan that doesn’t have to pass nondiscrimination testing. Prior to this change, a safe harbor plan sponsor couldn’t offer hardship withdrawals on similar terms as non-safe harbor plans. With this change, they will be able to. 

BL: What is the significance of dropping the requirement for the participant to take an available loan before taking a hardship distribution?

Zaklad: Again, it is better for the participant. The change avoids requiring a participant who has a one-time hardship event, such as an extraordinary medical expense for himself or herself, a dependent or beneficiary, to take a loan prior to obtaining a hardship distribution.

BL. What is the significance of doing away with the current rule that participants who take a hardship distribution can’t contribute to their plans for six months?

Zaklad: Plan sponsors, recordkeepers, and participants should welcome the elimination of this rule, which Congress ordered the IRS to accomplish within a year. It seems unfair that a person who experienced a one-time financial hardship should, in all cases, be prohibited from restarting deferrals for another six months. From the plan sponsor perspective, the six-month suspension is a trap for the unwary. Even if a plan sponsor is aware that the six-month suspension applies to all plans within the controlled group (including, for example, stock purchase plans), it’s not so easy to ensure compliance with this rule. Many plan sponsors have gotten tripped up by the six-month suspension rule, either in connection with suspending contributions or reinstating them.    

BL: Is a separate IRS regulation that requires a participant to take available distributions from other plans before taking a hardship distribution still in effect given the changes to hardship distributions in the budget law?

Zaklad: Currently, yes. Under the “deemed necessary” safe harbor (which is used by most plans), the requirement to take all other available distributions appears to be unchanged by this legislation. But the IRS has authority to expand the deemed necessary safe harbor–see Treas. Reg. § 1.401(k)-1(d)(3)(v). And the new legislation, in addition to requiring the IRS to eliminate the six-month suspension requirement, permits the IRS to make any other modifications necessary to carry out the purposes of the hardship distribution rules. Eliminating this requirement would be consistent with the budget act changes.

Many participants who request hardship distributions don’t participate in other plans, but there are some who do. For those participants, a plan sponsor offering safe harbor hardship withdrawals must have some way of evaluating whether their participants are eligible for distributions in any other plans, including nonqualified plans, before granting a hardship request. Historically, administering this requirement has been tricky where there are multiple plans sponsored by the employer and other entities treated as a single employer under the qualified retirement plan rules.

BL: What’s the impact on hardship distributions of the tax-reform change to casualty-loss deductions under IRC §165?

Zaklad: The TCJA limits casualty-loss deductions under Internal Revenue Code (IRC) § 165 between 2018 and 2025 to federally-declared disasters. The 401(k) regulations provide for certain “safe harbor” distribution events, including expenses for the repair of property damage to an employee’s home that would qualify for the casualty deduction under IRC § 165. These safe harbor events are deemed to be on account of an immediate and heavy financial need, and avoid the need for the plan sponsor to make a “facts and circumstances” determination of hardship. If a plan tracks the safe harbor and permits a hardship withdrawal for the repair of property damage not due to a federally-declared disaster, such a withdrawal could violate plan terms (and could potentially impact the plan’s tax-qualified status). This result seems unduly harsh.

Plan sponsors should check with their recordkeepers to see how the temporary change to IRC §165 will be administered in the safe harbor hardship distribution context. Any change to current processes will take some time to implement, so it is unfortunate that there was no lead time for this (likely inadvertent) change. I understand that the IRS may be aware of this issue, and will hopefully issue guidance soon. I will note that the 401(k) regulations give the IRS authority to expand the list of safe harbor hardship events.

BL: What steps should plan sponsors be taking now to prepare for these changes to the hardship distribution rules?

Zaklad: Other than the casualty loss deduction change, the new rules aren’t effective until plan years beginning after Dec. 31, 2018. So there is still time to consider how these changes could affect plan operations. Plan sponsors should check with their recordkeepers or, if hardship distributions are administered in-house, with the individuals who review and approve hardship requests. It will be important to look at relevant paperwork, including hardship request forms, certifications, and any communications describing the hardship distribution process. A plan sponsor may also consider checking with payroll to see how the post-hardship suspensions are implemented, as it may take some time to make changes to payroll processes. Plan sponsors should also check plan documents and summary plan descriptions and consider what provisions may need to be amended, although it may make sense to wait for IRS guidance before amending the plan document.

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