401(k) Hardship Withdrawals, Account Transfers Might Get Easier

Proposed changes would free up funds for emergencies, but could hurt workers’ savings

Stephen Miller, CEBS By Stephen Miller, CEBS November 15, 2018
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Taking hardship withdrawals from 401(k) plans may soon be easier for plan participants, while plan sponsors could face fewer risks when transferring small "left behind" 401(k) accounts to departing employees' individual retirement accounts (IRAs) and new 401(k) plans.

Hardship Withdrawals Less Punitive

On Nov. 14, the Treasury Department and IRS published a proposed rule on hardship distributions that would relax several existing requirements.

Unlike loans, hardship withdrawals are not repaid to the plan with interest, so they permanently reduce the employee's account balance. Hardship withdrawals also are subject to income tax and, if participants are younger than age 59½, a 10 percent early withdrawal penalty. For these reasons, withdrawals should be a last-ditch option for employees facing financial hardship.

Congress, in the Bipartisan Budget Act passed in February, determined that some of these requirements were making it difficult for employees to take needed distributions and then to rebuild their retirement savings. The proposed rule, if finalized, would address these concerns by:

• Eliminating the six-month contribution-suspension requirement. Currently, participants who take a hardship distribution are barred from making contributions to the plan for six months. Under the proposed regulations, plan sponsors could, if they wish, as of 2019 get rid of the suspension period for plan years beginning Jan. 1. For distributions made in the second half of 2018, plan sponsors could end the suspension period for new contributions as of Jan. 1.

Starting Jan. 1, 2020, plans would no longer be able to suspend contributions following a hardship distribution.

Eliminating the contribution suspension "could have a mixed effect on leakage from 401(k) plans" by encouraging more hardship withdrawals but letting those who take distributions rebuild their savings sooner, said Lori Lucas, CEO of the nonprofit Employee Benefit Research Institute in Washington, D.C.

Employees often "do not continue saving for their retirement [after the six-month suspension] and often miss out on the company match," said Robyn Credico, practice leader of defined contribution consulting at Willis Towers Watson, an HR advisory firm.

• Ending the need to take a plan loan before a hardship withdrawal. Another existing requirement is that participants first take a plan loan, if available, before making a hardship withdrawal. The new rule would remove this requirement for distributions made in plan years beginning Jan. 1, 2019. Unlike the elimination of the six-month suspension period, removing this requirement would not be mandatory, so plans could continue to require participants to take a plan loan before being eligible for a hardship withdrawal.

"Many plan sponsors view [the loan-first requirement] as desirable, since it minimizes plan leakage," explained Michael Webb, vice president at Cammack Retirement Group, a benefits consultancy in New York City.

• Making earnings available for withdrawal. Effective in 2019, earnings on 401(k) contributions could be distributed for hardships, as could profit sharing and stock bonus contributions. Previously, employees could only withdraw contributions, not earnings.

Earnings on 403(b) contributions would remain ineligible for hardship withdrawals because of a statutory prohibition that Congress didn't amend.

• Providing disaster relief. Currently, to take a hardship withdrawal employees must show an immediate and heavy financial need that involves one or more of the following: purchase of a primary residence; expenses to repair damage or to make improvements to a primary residence; preventing eviction or foreclosure from a primary residence; post-secondary education expenses for the upcoming 12 months for participants, spouses and children; funeral expenses; and medical expenses not covered by insurance.

Among other changes, the proposed rule would add a seventh safe harbor category for expenses resulting from a federally declared disaster in an area designated by the Federal Emergency Management Agency. "This addition is intended to eliminate uncertainty or delays in receiving distributions in the absence of special IRS guidance [to allow hardship withdrawals], which has historically been issued in these situations," noted Jake Downing and Jessica Stricklin, attorneys with Seyfarth Shaw in Chicago.

• Easing hardship requirements. Under the rules now in place, plan administrators must take into account "all relevant facts and circumstances" to determine if a hardship withdrawal is necessary. The proposed rule only requires that a distribution not exceed what an employee needs (including any money to pay taxes or penalties) and that employees must certify that they lack enough cash to meet their financial needs.

Plan administrators would be allowed to rely on that certification unless they have knowledge to the contrary. Plans could choose to apply this standard as of 2019 and would be required to do so starting in 2020.

"These are just proposed regulations, so it is possible that the final version may differ," Webb noted.

The IRS is accepting comments on the proposal through Jan. 14, 2019.

Plan Amendment To Be Required

"Plans that permit hardship distributions will need to be amended to reflect these new hardship distribution rules once the regulations are finalized," wrote Russell Hirschhorn and Stacey Cerrone, partner and senior counsel, respectively, in the New York City and New Orleans offices of law firm Proskauer Rose. "The general rule is that plans have until the end of the second calendar year beginning after the issuance of an IRS-issued "Required Amendments List" reflecting the new rules," they pointed out. "That is the outside date for amendments, however. Plan sponsors should consider plan amendments well in advance of any final deadline."

Joshua Rafsky, an attorney in the Chicago office of Jackson Lewis, noted that "Plan administrators may also want to consider whether updates are needed to the plan’s summary plan description and other communications documents that describe the plan’s hardship rules, and to election forms and online election pages."


[SHRM members-only toolkit:
Designing and Administering Defined Contribution Retirement Plans]

DOL Seeks Comments on Auto Portability

Another proposal might keep retirement savings intact when an employee finds a new job.

In early November, the U.S. Department of Labor (DOL) issued Advisory Opinion 2018-01 in response to a request from Retirement Clearinghouse LLC about plan sponsors' obligations under the Employee Retirement Income Security Act (ERISA) when using the firm's automatic portability program. That program is intended to discourage employees with small 401(k) account balances from cashing out these funds when changing jobs.

Under an auto portability program like the one in question, departing employees are told that 401(k) balances under $5,000 will be moved to tax-favored IRAs when they leave a job and that the amount will then be automatically transferred to the new employer's 401(k) when the employee finds a new job. Retirement Clearinghouse's system, now being developed, would use recordkeepers' data to find a departing employee's new plan and facilitate the transfer.

"When plan sponsors or other responsible fiduciaries choose to have a plan participate in the [auto portability program] they are acting in a fiduciary capacity, and would be subject to the general fiduciary standards and prohibited transaction provisions of ERISA in selecting and monitoring [the program]" with regard to fees charged to the participants' accounts, for instance, the DOL's advisory opinion stated.

The DOL, however, also published a notice of proposed ERISA exemption and posted a news release inviting public comment on a proposal to limit plan sponsors' fiduciary risks when using this approach. 

The notice said that Retirement Clearinghouse plans to charge participants' accounts a transfer fee of up to $59, or 10 percent of the account balance up to $590. Account balances of $50 or less would not pay a transfer fee.  

"Because the prohibited transaction provisions of ERISA and the Internal Revenue Code prohibit a plan fiduciary from using its discretion to cause the plan or IRA to pay the fiduciary a fee, implementation of this type of program would require a prohibited transaction exemption," explained attorneys at the Wagner Law Group in Boston.

The DOL cited the possibility that automatic transfers would "eliminate duplicative fees for small retirement savings accounts and reduce leakage of retirement savings from the tax-deferred retirement savings system" and said that it "looks forward to receiving input from the public, including any data or factors that it should consider as part of the exemption, including protective conditions for participants and beneficiaries."

Automatically transferring small 401(k) accounts could leave departing participants with larger nest eggs since they would be less likely to cash out retirement funds, and the practice could appeal to plan sponsors who find it administratively costly to maintain small-balance accounts in their 401(k) plans.

While the proposed rule and further auto-portability guidance would allow plan sponsors to simplify their plan's administration and fiduciary risk, "it is unclear what responsibility the plan sponsor would retain for data security and accurate processing," posted Jana Steele, senior vice president and defined contribution consultant at investment advisory firm Callan. "Auto-portability programs may be limited by recordkeepers' willingness to share participants' personally identifiable information with a third party and may also be hindered by administration and transfer fees."

The DOL is accepting comments on the proposed exemption through Dec. 24, 2018.

Related SHRM Articles:

Retirement Plans Are Leaking Money. Here's Why Employers Should Care, SHRM Online, October 2017

Might 'Auto Portability' Reduce 401(k) 'Leakage'?, SHRM Online, August 2016


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