Budget Law Eases 401(k) Hardship Withdrawals

Measure provides flexibility for employees facing emergencies and financial challenges

Stephen Miller, CEBS By Stephen Miller, CEBS February 13, 2018
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Hardship withdrawals from employer-sponsored 401(k) and 403(b) retirement plans will be easier to make under new provisions in the budget law passed Feb. 9. The legislation also takes steps toward ensuring the ongoing solvency of multiemployer defined benefit pension plans.

Under current rules for 401(k) and similar defined contribution plans, hardship distributions are limited to the elective deferral amount contributed by plan participants, and employees are prohibited from making new contributions for six months after making a hardship withdrawal.

Those constraints won't apply much longer, however. The Bipartisan Budget Act will allow employees not only to withdraw their own money but also to take the earnings on the money and company contributions as part of a hardship withdrawal.

Significantly, "employees who take hardship withdrawals would not be required to suspend their contributions to the plan, thereby allowing them to continue to get the company match and not have to remember to rejoin the plan when the suspension ends," said Robyn Credico, practice leader of defined contribution consulting at Willis Towers Watson, an HR advisory firm.

"Collectively, these provisions will help people facing emergencies or financial challenges to put money they withdraw from their 401(k) plan back into the plan and allow them to continue saving for retirement," said James Klein, president of the American Benefits Council in Washington, D.C., which represents benefit plan sponsors.

A big difference between loans and hardship withdrawals is that loans are temporary withdrawals to be paid back with interest, while hardship withdrawals do not have to be paid back, but they invoke a 10 percent penalty as well as taxes.

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

Key Changes

As outlined in a summary from the National Association of Plan Advisors, the budget act:

  • Removes the six-month prohibition on contributions to retirement plans after a hardship withdrawal. The act directs the IRS to change its administrative guidance to allow employees who take hardship distributions from a retirement plan to continue contributing to the plan. The revised regulations will apply to plan years beginning in 2019.
  • Removes the requirement for participants to first take a loan from their plan account before taking a hardship withdrawal, effective in 2019.
  • Permits employers to extend hardship distributions to amounts not previously permitted. The act allows a plan participant to withdraw the plan sponsor's qualified nonelective contributions, qualified matching contributions and profit-sharing contributions, effective in 2019.
  • Provides relief for a withdrawn federal tax levy on retirement plan assets. The act allows an individual to recontribute to an employer-sponsored plan (if the plan so allows) or to an individual retirement account (IRA) an amount withdrawn—and interest earned on that amount—to satisfy an IRS levy on plan assets if the withdrawn funds were later returned to the individual by the IRS. This provision is effective retroactively as of Jan. 1, 2018.
  • Provides California wildfire relief. The act extends to victims of the California wildfires relief similar to that available for those affected by hurricanes Harvey, Maria and Irma, which includes relief from the 10 percent early-withdrawal penalty for qualified distributions up to $100,000 made on or after Oct. 8, 2017, and before Jan. 1, 2019.
    Distributions must be made by an individual whose principal place of residence was in a wildfire disaster area and who sustained an economic loss due to the wildfires. The act also permits individuals to recontribute funds to retirement plans if the funds were withdrawn for a home purchase in a wildfire disaster area that was canceled on account of the wildfires.

Eliminating the six-months prohibition against making plan contributions after taking a hardship withdrawal "could have a mixed effect on leakage from 401(k) plans—potentially encouraging more hardship withdrawals, while at the same time reducing the amount of [lost] savings," said Lori Lucas, CEO of the nonprofit Employee Benefit Research Institute in Washington, D.C.

"The prohibition on participants making contributions after taking a hardship withdrawal has been difficult to administer," noted Credico, since it requires plan administrators to restart employee deferrals after the six-month suspension and "when this doesn't happen, employees do not continue saving for their retirement and often miss out on the company match."

Eliminating the requirement that participants take a plan loan before taking a hardship withdrawal "is also helpful, as those in need of a hardship withdrawal cannot generally afford loan repayments," Credico said, and may be better off contributing what they can, when they can, to their plans through salary deferrals.

Added Marina Edwards, a senior retirement consultant at Willis Towers Watson, "Many participants who experience a hardship withdrawal may only need that single distribution to clear their financial pinch, and once cleared, they may be able to continue contributing to the plan and receive the match."

Beware a Savings Drain

Employers should caution workers that borrowing money from their retirement accounts now could severely limit their future savings.

"The loss of retirement assets from a hardship withdrawal could be significant," said Jack Towarnicky, executive director of ‎Plan Sponsor Council of America, an employers group. Plan sponsors that implement the new provisions "may want to incorporate information in their financial wellness program about how hardship withdrawals impact retirement savings and wealth accumulation" and may want to encourage workers to take a loan from their plan assets before electing a hardship withdrawal, he advised.

However, he added, workers are more likely to take hardship withdrawals "as a last resort, a form of safety measure to address unforeseen circumstances." The new law "compassionately lowers the cost by eliminating the [six-month] suspension of contributions" following a hardship distribution, Towarnicky said.

Reminder: Tax Law Altered Loan Repayment Deadline

Prior to last December's enactment of the Tax Cuts and Jobs Act, 401(k) and similar defined contribution plan participants whose employment ended with a plan loan outstanding had to repay the loan within 60 days of their departure. Those who failed to do so were considered to have defaulted on the loan, requiring them to pay income tax on the loan's balance. Borrowers younger than 59½ also had to pay a 10 percent penalty.

Beginning this year, the tax act extended the deadline for repaying the loan to the latest date on which the participant can file his or her tax return for the year in which the loan amount was treated as a distribution.

After a separation from service, borrowers also can avoid having their loan become a taxable withdrawal by contributing (by the tax filing deadline, including extensions) to an IRA or to another qualified employer plan an amount equal to the repayment terms of the loan. The contribution is then treated as a rollover that offsets the outstanding loan.

"The only action required by employers is to make sure that participants are properly notified of the new rule when the loan offset occurs, which should be the case if the participant is given an updated Special Tax Notice, or a supplement to the Special Tax Notice until it is updated by the IRS," noted Frank Berrodin, an attorney with Miller Johnson in Grand Rapids, Mich.


Multiemployer Pension Solvency

The budget act creates a congressional joint select committee to address multiemployer pension plan solvency issues. The goal is to develop a bipartisan legislative solution to keep these plans, and the Pension Benefit Guaranty Corp. (PBGC), solvent.

The committee will be composed of 16 members from both parties and both houses of Congress. Should the committee approve draft legislation, the bill will receive expedited consideration in the Senate.

Over the years, Republicans have proposed cutting multiemployer pension benefits and raising PBGC premiums while Democrats have called for increasing government assistance to severely underfunded plans.

"Some of the largest multiemployer plans are in danger of completely running out of assets," said John Lowell, an Atlanta-based partner at October Three Consulting, a pension advisory firm. "Congress is to be applauded for its upcoming efforts to address the crisis that exists with multiemployer pension plans. Unfortunately, all previous attempts at fixes have used the Band-Aid approach that has tried to repair an incredibly broken system with little tweaks."

A comprehensive solution "would need to infuse sufficient assets into the system to make the failing plans solvent for an extended period of time and to find a way to keep them solvent," Lowell said. A fix that involves reducing future payouts, however, "is likely not to be tenable to organized labor. Congress faces an uphill battle to avoid the only obvious solution—a government bailout."

Related SHRM Article:

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

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