By Jane Meacham, Contributing Editor

The Bipartisan Budget Act of 2018 enacted in February relaxed certain restrictions on hardship withdrawals from 401(k) and 403(b) retirement plans (see, New Federal Budget Relaxes Hardship Withdrawals for Retirement Plan Participants), starting in 2019. But defined contribution (DC) retirement plan sponsors also should be aware that, in contrast, the federal Tax Cuts and Jobs Act (TCJA) signed in December 2017 has made ineligible hardship distributions used to pay for damage to a plan participant’s primary residence not caused by a federally declared disaster.

As a result, plan sponsors will want to review immediately with this change in mind their safe harbor hardship distribution procedures for participants’ property-damage claims.

Previous Policy

Previously, law dealing with casualty loss deductions allowed taxpayers to claim a deduction for property losses caused by heavy winds, storm water, extreme snow or ice, fires, and similar events. Under 401(k) and 403(b) plan regulations, hardship distributions may only be made to relieve a participant’s immediate and heavy financial need. The regulations allow plans to satisfy this requirement through either a “facts and circumstances” analysis or six “safe harbor” categories.

Change Made By TCJA

As of January, however, the safe harbor category in these regulations covering damage to a 401(k) or 403(b) plan participant’s home, which previously made hardship distributions available for the types of disasters noted above, is now limited to those occurring in a federally declared disaster area.

“One possibility [for DC plan sponsors] would be to follow the letter of the law and limit hardship distributions to home repair costs arising from a federally declared disaster,” said benefits consulting firm Willis Towers Watson (WTW) in a March 9 client bulletin.

Or, the firm said, sponsors of individually designed plans might consider switching to the more flexible facts-and-circumstances approach to granting hardship distributions—although the switch could complicate plan administration.

Another option for some sponsors may be to adopt a wait-and-see approach, as the Internal Revenue Service (IRS) might modify its regulations to continue permitting hardship distributions in accordance with the prior law, according to WTW. “The fact that the [Bipartisan Budget Act] … directs the IRS to amend the hardship distribution regulations increases the chances that the agency will address the casualty loss issue as well,” the bulletin states.

Provisions Relaxed by Budget Act

The Budget Act kept alive several proposals debated during the TCJA’s finalization in late 2017 while relaxing some restrictions related to DC plan hardship withdrawals, although adopting these changes is optional for plan sponsors.

Specifically, the new budget law:

• Directs the IRS to make changes to hardship distribution regulations to eliminate the existing safe harbor rule that prohibits individuals from making elective deferrals for 6 months after a hardship distribution, and make any other changes necessary to carry out the purposes of the hardship distribution rules;
• Provides that qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), and earnings on such contributions may be made available for hardship distributions (previously, only participant elective deferrals and pre-1989 earnings on them were eligible for hardship distributions); and
• Eliminates the requirement that individuals take any available plan loans before seeking a hardship distribution.

The budget law also eased the return to participant accounts of wrongful levies assessed by the IRS and set up a joint congressional committee to review the solvency problems faced by multiemployer pension plans.

“Plan sponsors will need to review the changes to the hardship rules enacted by tax reform and the budget act, amend their plan in a timely fashion so the language conforms to its administration, and update related hardship distribution forms and plan communications,” WTW advised.