The IRS issued a final rule in September 2019 that makes it easier for participants to take a hardship withdrawal. It also limited the verification requirements of the plan sponsor. The provisions take effect on January 1, 2020 and plans will need to be amended. The deadlines for the formal amendments will fall after the effective date and will vary based on type of plan.
The major changes of the ruling include:
- Eliminating the six-month contribution suspension. This provision could potentially offset a portion of the “leakage” resulting from hardship distributions.
- Making the requirement for participants to take a loan prior to a hardship withdrawal optional. As this provision is optional, certain plan sponsors may elect not to adopt it in an attempt to mitigate “leakage.”
- Expanding amounts available for distribution. Previously, only participant elective deferrals were eligible for a hardship distribution. The new rules also allow distribution of safe harbor contributions, QNECs and earnings. This is also an optional provision.
- Permitting plan sponsors to rely on participants’ certification of their financial need and that they lack the financial resources to meet the need. This provision seemingly would be welcomed by plan sponsors as it eases the burden on them. However, plan sponsors will still have some limited requirements.
- Adding an additional financial need safe harbor category related to federally declared disaster areas by the Federal Emergency Management Agency. This change will certainly be welcomed by participants in our location of Northern California.
While these new rules make it easier for participants to take hardship withdrawals, they should still be used as a last resort. One obvious drawback is that the withdrawal is a permanent reduction in the participant’s retirement savings. Also, the withdrawal is taxable and subject to a 10% early withdrawal penalty (for those younger than 59½). A plan loan, if available, is the better option. Unless the loan is defaulted, there is no tax impact and the loan repayments go back into the participant’s account.
Do You Know?
For 2020, maximum 401(k) contributions for employees will increase by $500 to $19,500 and the “catch up” contribution for those 50 and older will also increase by $500 to $6,500. The combined employer and employee maximum will increase by $1,000 to $57,000.