Unintended Consequence of Tax Cuts and Jobs Act Tightens Up 401(k) Hardship Distribution Rules; Budget Act Eases Restrictions
For retirement plans that authorize hardship distributions, plan sponsors should be cognizant of the impacts the Tax Cuts and Jobs Act (the “TCJA”) and the Bipartisan Budget Act (the “Budget Act”) may have on plan administration related to such distributions. First, the TCJA may indirectly affect plan administration in light of changes to the casualty loss rules under § 165 of the Internal Revenue Code (the “Code”). Second, the Budget Act directly changes the rules on hardship distributions by easing the circumstances under which such distributions are allowed.
For tax years beginning January 1, 2018, through January 1, 2026, the TCJA limits the deductibility of casualty losses under § 165 of the Code. This change in the tax law may have an unintended consequence related to hardship distributions: a participant now may only receive a safe harbor hardship distribution for damage to his or her principal residence if the damage was caused by a Federally declared disaster. While this change does not necessarily require an amendment to plan documents, plan sponsors may wish to amend the summary plan description to clarify that hardship distributions made for damage to a participant’s principal residence, if not caused by a Federally declared disaster, will no longer be permitted.
In contrast, the Budget Act eased certain restrictions imposed on safe harbor withdrawals, including the following:
- The base from which hardship withdrawals can be taken was expanded: effective January 1, 2019, employees may now withdraw the amount of the aggregate elective contributions or qualifying matching contributions that have been made, plus any earnings accrued on those contributions. Plan sponsors may wish to amend the Plan to allow earnings on elective deferrals or qualifying matching contributions to be included in the hardship distribution.
- The 6-month prohibition on making elective deferral contributions to the Plan after receiving a hardship distribution will no longer be required beginning January 1, 2019. Plans may be amended to provide that employees will continue to make contributions to the Plan in accordance with their deferral election after receiving a hardship distribution.
- The requirement that a participant first obtain a loan under the plan before requesting a hardship withdrawal will no longer be required beginning January 1, 2019. Plan sponsors may amend their plans to eliminate the requirement that a participant has obtained all nontaxable loans currently available under all plans maintained by the employer.
Allowing hardship distributions remains elective for 401(k) plan sponsors, but plan amendments and revisions to summary plan descriptions may be necessary to account for these recent changes in the law and to promote consistent plan administration.