U.S. Treasury Changes 401(k) and 403(b) Hardship Withdrawal Rules

The U. S. Department of the Treasury recently issued final regulations governing hardship distributions from 401(k) and 403(b) retirement savings plans. 

Section 401(k) and 403(b) plans aim to assist employees in saving for retirement. To encourage employees to make contributions, these plans allow participants to access their savings prior to retirement in certain limited circumstances, including a severe financial hardship for the participant or his or her beneficiaries. The new regulations make changes to the process that determines whether a participant may receive a hardship withdrawal from his or her 401(k) or 403(b) plan account. These changes reflect recent legislative developments.

An in-service hardship withdrawal is only available if the participant (or their beneficiary) has an “immediate and heavy financial need.” For participants to meet this standard under the current regulations, plans may require participants to first obtain any available loans offered under the plan and may prohibit the participant from making contributions for six months following the hardship withdrawal. Also, qualified non-elective contributions (QNECs), qualified matching contributions (QMACs), and investment earnings on elective deferrals have historically not been available for hardship withdrawals.

The final regulations apply a more flexible standard for determining whether a participant has an immediate and heavy need. The regulations also expand the available sources of hardship withdrawals. Under the new regulations, a plan may provide that a hardship withdrawal will be available only if:

• The withdrawal does not exceed the participant’s need (plus amounts necessary to pay any taxes or penalties resulting from the withdrawal);
• The participant first obtains other available non-hardship withdrawals from the employer’s other plans; and
• The participant certifies that he or she has insufficient liquid assets available to satisfy the need. However, if the plan administrator has actual knowledge to the contrary, the “immediate and heavy” standard will not be met.

Additionally, the new regulations permit 401(k) plans to authorize hardship withdrawals from QNECs, QMACs, and their investment earnings on elective deferrals. However, investment earnings on elective deferrals under a 403(b) plan are still unavailable for hardship withdrawals, and QNECs and QMACs under a 403(b) plan that are in a custodial account are also ineligible for distribution on account of hardship.

Additional Guidance

The new regulations also:

• Clarify that an immediate and heavy financial need may include the need to repair or replace a participant’s principal residence resulting from damage on account of a federally-declared disaster without requiring that the residence be located in the federally-defined disaster zone; and
• Provide that an immediate and heavy financial need may arise when a participant’s “primary beneficiary” incurs certain medical, educational, and funeral expenses.

Important Dates

The new regulations apply to all hardship withdrawals made on or after January 1, 2020.  However, plans may elect to apply the new regulations for plan years beginning after December 31, 2018.

All 401(k) and 403(b) plans will need to be amended to reflect the new regulations. Assuming that the new rules are included in the 2019 Required Amendments List published by the Internal Revenue Service, the amendment deadline for individually designed 401(k) plans is December 31, 2021. The amendment deadline for pre-approved (or volume submitter) 401(k) plans is the tax filing deadline following the 2020 plan year. The remedial amendment deadline for 403(b) plans is March 1, 2020, however the Treasury Department and IRS are considering a later deadline for amendments relating to the final regulations.

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