- Safe harbor hardship for repair of principal residence must be attributable to federally declared disaster.
- Requirements for hardship distributions relaxed and eligible account sources expanded.
- Disability claims procedure update.
- Plan loan offset rollover period extended in the case of plan terminations or severance from employment.
Two Congressional acts have made more plan funds available for hardship distribution and relaxed the requirements for receiving a hardship distribution but have also indirectly curtailed one of the circumstances in which a hardship distribution may be requested. The first act was the Tax Cuts and Jobs Act (“TCJA”), which was signed into law on December 22, 2017.
Expenses for repair of principal residence limited to federal disaster
A hardship distribution must be made on account of an immediate and heavy financial need of the employee. Whether there is an immediate and heavy financial need is a facts and circumstances test but the IRS does provide six safe harbor circumstances that are deemed to be an immediate and heavy financial need. One of those safe harbors circumstances is expenses incurred to repair damage to the employee’s principal residence that would qualify for the casualty deduction under Internal Revenue Code section 165.
Section 165 allows individuals a deduction on non-business casualty losses not compensated for by insurance. The TCJA added a requirement that the casualty loss must be attributable to a federally declared disaster to be deductible. Unless the IRS provides guidance otherwise, hardship distributions will not be available for repairs to an employee’s principal residence in the absence of a federally declared disaster after December 31, 2017.
The second act is the Bipartisan Budget Act of 2018 (the “Act”), which was signed into law on February 9, 2018. It contains several provisions affecting hardship distributions from qualified retirement plans for plan years beginning after December 31, 2018. The Act changed hardship distributions in the following ways:
Elimination of six-month suspension following hardship distribution
The hardship distribution rules contain a safe harbor for when a hardship distribution will be deemed necessary to satisfy an immediate and heavy financial need. The safe harbor currently requires plans to suspend participants from making contributions for a period of at least six months after a hardship distribution. This waiting period is eliminated in the Act.
Elimination of requirement to take loans prior to hardship distribution
The above-described safe harbor currently requires participants to take all available plan loans prior to hardship distribution. The Act removes this requirement as well.
Availability of more sources for hardship distributions
Hardship distributions are currently not allowed from the following sources: i) post-1988 investment earnings on pre-tax and Roth contributions; ii) qualified nonelective contributions; or iii) qualified matching contributions. The Act allows for hardship distributions from all of these sources, including earnings. The Act also clarifies that hardship distributions may be made from all other amounts under a 401(k) or profit sharing plan.
It is not mandatory for plans to adopt these changes. The hardship distribution rules provide the limitations that plan hardship policies must operate within but plans can impose more conservative hardship rules than those provided by statute. Plan sponsors can implement these changes in their plans if they adopt an amendment by the last day of the plan year in which the changes are implemented. INTRUST intends to apply these new rules to hardship distributions for all plans. Please contact your Retirement Advisor if you do not want to implement these changes in your plan or to discuss the impact these changes would have on your plan. We will have an amendment ready for adoption by the end of 2019.
Disability Claims Procedure
The Department of Labor amended its regulations governing the procedures by which claims for disability benefits are processed by plans subject to ERISA. This amendment went into effect on April 2, 2018. If your plan is using our prototype plan document then you do not need to take any action as the current disability claims procedures already satisfy the new regulations. The summary plan description contains the disability claims procedures. If your plan is not using our prototype plan document, your document provider should have contacted you regarding the status of your plan’s disability claims procedures. If they have not contacted you, we would advise you to contact them to ensure your procedures are in compliance. If your plan is not using our prototype document and you would like to inquire about switching to our prototype document, please contact your Retirement Advisor.
Plan Loan Offset Rollover Period
A plan may provide that if a loan is not repaid, the participant’s account balance is reduced, or offset, by the outstanding loan balance. A defaulted loan cannot be offset until the participant is eligible to receive distributions (e.g. age 59 ½ or severance from employment). If the participant is not eligible for distributions at the time of the default, then the outstanding balance of the loan will be treated as a taxable distribution from the plan in a “deemed distribution” but the loan will continue to be outstanding and included in their account balance. Once the participant is eligible for distribution their account balance will be offset (reduced) by the outstanding loan balance. The loan offset in this case is not rollover eligible because no distribution is made at that time.
On the contrary, the account balance of a participant that is eligible for distributions at the time of default will be offset by the outstanding loan balance and the loan offset is treated as an actual distribution eligible for rollover within 60 days. The Tax Cuts and Jobs Act extends the rollover period in the case of a plan loan offset resulting solely from the termination of the plan or the participant’s severance from employment. In those two cases, the loan offset may be rolled over by the due date, including extensions, for filing the participant’s tax return for the tax year in which the amount is treated as distributed.
For example, John, is a participant in plan B which allows distributions in the event of a severance from employment. John terminates employment in 2018 and defaults on his loan. His loan would be offset against his account balance (removed from his account balance) because he has become eligible for distribution. The amount of the loan offset would be treated as an actual distribution and John would have until October 15, 2019, if he extends his 2018 return filing deadline, to contribute the amount of the offset loan balance to another qualified plan or IRA to complete the tax-free rollover.