Hardship Distributions – IRS Clarifies Bipartisan Budget Act of 2018

The Bipartisan Budget Act of 2018 (BBA) made several changes with respect to Section 401(k) and 403(b) plans. The IRS recently issued a proposed amendment to the hardship distribution regulations to reflect the changes that BBA made to hardship distributions. The proposed amendment to the regulations provides more time for plan sponsors to implement the BBA changes and provides some clarifications as well as helpful insights into the BBA changes. While formal amendments are not required to be adopted during 2018, plan sponsors may need to provide instructions to their plan recordkeeper prior to the deadline for adopting formal amendments, and may choose to adopt amendments to reflect those instructions. Plan sponsors should contact their third-party plan administrators and legal counsel to discuss these changes.

What’s Changed?

Effective for plan years beginning after Dec. 31, 2018, the BBA made the following changes to hardship withdrawals:

• Eliminates the requirement that elective deferrals be suspended for a period of six months following a participant’s receipt of a hardship distribution. Under the proposed amendment to the regulations, while sponsors may eliminate the six month suspension for plan years beginning on or after Jan. 1, 2019, plan sponsors must eliminate the suspension required for plan years beginning on or after Jan. 1, 2020.
• Eliminates the requirement that a participant must take any available loans under the plan prior to taking a hardship distribution.

In addition,  the BBA expanded the sources from which hardship withdrawals may be drawn in a Section 401(k) plan (profit-sharing and stock bonus plans were never subject to these restrictions). Effective for plan years beginning after Dec. 31, 2018, a plan sponsor may amend a Section 401(k) plan to permit hardship distributions from:

• Earnings on contributions (including earnings on elective deferrals after Dec. 31, 1988)
• Qualified nonelective contributions
• Qualified matching contributions

As noted above, permitting hardship withdrawals from these additional sources is optional. Plan sponsors will need to weigh the pros and cons, including expanded flexibility versus promoting retirement savings, in determining whether and how far to revise a Section 401(k) plan’s hardship withdrawal provisions.   

Section 403(b) Plans

The current regulations under Section 403(b) generally incorporate the Section 401(k) regulation rules on hardship distributions. Consequently, Section 403(b) plans are also impacted by the BBA. Specifically, Section 403(b) plans that rely on the Section 401(k) safe harbor should be amended to remove the six-month suspension rules, and may choose to eliminate the requirement that a participant take any available plan loans prior to taking a hardship distribution. 

Although 403(b) plans generally follow the hardship rules for 401(k) plans, there are some differences. The preamble to the proposed amendment specifically did not expand hardship distributions from 403(b) plans to include earnings on contributions or QNEC or QMAC amounts that are not in a custodial account.

We encourage plan sponsors to review their hardship distribution rules and consider whether and to what extent to make permitted changes.