IRS Issues Summary Regarding Hardship Distributions From 401(K) Plans

The IRS uses “Issue Snapshots” to analyze tax issues and provide links to additional resources such as Tax Code sections and regulations, revenue rulings, and IRS webpages. The IRS does not use issue snapshots as a comprehensive discussion of all issues related to a covered topic. Snapshots do not limit the IRS’s ability to use other approaches in examinations.

The IRS has updated its “Issue Snapshot” summarizing the requirements for Hardship Distributions From 401(k) Plans. These latest updates incorporate changes made by the Bipartisan Budget Act of 2018. The updated issue snapshot exclusively focuses on the current rules and foregoes virtually all mention of the restrictions that applied to hardship distributions before 2020, which is before the effective date of the amended regulations. 

The Bipartisan Budget Act of 2018 expanded the sources of funds for hardship distributions, removed the requirement for participants to exhaust available plan loans, and directed the IRS to delete the safe harbor requirement that elective deferrals and employee contributions be suspended after a hardship distribution. 

Qualified retirement plans are subject to a variety of distribution restrictions. A 401(k) plan may permit the distribution of certain contributions and attributable earnings because of an employee’s hardship.However, this only applies if the distribution is made according to the rules contained in the regulations.  The determination of the existence of this need – and of the amount necessary to meet the need – must be made according to objective and nondiscriminatory standards outlined in the plan.

The snapshot reflects legislative changes that created a single standard for determining whether a distribution is necessary to satisfy a participant’s need. The snapshot also summarizes the current minimum requirements for determining whether a distribution is necessary.

Considering only the current application of the amended regulations, the issue snapshot:

  • Explains the expansion of hardship distributions to include earnings, qualified matching contributions (QMACs), and qualified nonelective contributions (QNECs); 
  • Clarifies that anticipated and voluntary expenses may qualify as hardship needs; and 
  • Reflects the expansion of qualifying needs to include hardships relating to medical, education, and funeral expenses for primary beneficiaries of the participant. 

Deciding whether an employee has an immediate and heavy financial need is based on all relevant facts and circumstances of the distribution. A financial need may be immediate and heavy even if reasonably foreseeable or voluntarily incurred by the employee.

Plans that permit hardship distributions should already have implemented the legislative and regulatory changes reflected in the new IRS snapshot, including the elimination of elective deferral suspensions after hardship distributions. However, some plans may not yet have incorporated the changes into their plan documents and should do so at the earliest possible date. 

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