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Retirement Plan Design Considerations for Hardship Withdrawals

Feb 21, 2018

On February 9, 2018, the Bipartisan Budget Act of 2018 (the “Budget Act”) was approved by Congress and signed into law by President Trump. This law passed not only to fund the federal government, but also to provide important changes to retirement plans, including provisions that expand hardship withdrawals from 401(k) and 403(b) plans. Plan sponsors will need to carefully consider these provisions.  The changes are effective for plan years beginning after December 31, 2018.

Primary Changes

Six-Month Suspension Requirement Eliminated

Under current IRS guidance, any plan that wishes to take advantage of the regulatory safe harbor for hardship withdrawals must suspend a participant’s elective deferral contributions, including contributions to other qualified and nonqualified plans, for a period of six months following the withdrawal.

The Budget Act instructs the Internal Revenue Service to remove this requirement. Thus, a participant who obtains a hardship withdrawal is no longer required to suspend contributions to the plan for six months. This should help simplify administration of the plan and alleviates the plan sponsor requirement of having to take action to suspend the deferral contribution, a common operational error with qualified plans.

Additional Amounts Available for Hardship Withdrawals

Under current law, hardship withdrawals are available only from the original contributions made to the elective deferral money source—both pretax and Roth. Earnings on elective deferrals may not be withdrawn for financial hardship (other than earnings accrued before 1989). In addition, a hardship withdrawal is prohibited for certain types of employer contributions known as “qualified non-elective contributions” (QNEC) or “qualified matching contributions” (QMACs), including safe harbor contributions.

These restrictions on hardship withdrawals are eliminated under the new law. This is welcome news because the current rules make it difficult for third-party administrators to track the basis of the original contributions, especially for takeover plans. Keep in mind that other types of employer contributions will continue to be subject to restrictions on in-service withdrawals, including elective deferrals prior to age 59 ½ and money purchase pension contributions.

Participant Loan Provisions

The current law for safe harbor hardship withdrawals requires a participant to exhaust all other options for available distributions before obtaining a hardship withdrawal. This requirement also applies to participant loans and includes loans available under other qualified plans, if applicable.

The law removes the requirement that a participant obtain all available loans before obtaining a hardship withdrawal. It does not remove the requirement that a participant first exhaust all other available distribution options. Therefore, if a plan makes other types of contributions available for in-service withdrawal (excluding hardship distributions), a plan administrator would have to continue applying this restriction.

Employer Options

The changes noted above are optional, so a plan amendment will be required in order to adopt them. Plan sponsors may want to consider the following:

Enhancing Retirement Security

One option for plan sponsors of 401(k) and 403(b) plans would be to simply leave their current hardship withdrawal provisions in place. One could argue that making it easier to increase such withdrawals is not in a participant’s best interest because it increases “leakage.” Loans must be repaid, which increases the likelihood that the funds will be returned to the participant’s account in the plan. Hardship distributions cannot be repaid. The requirement that participants take all available loans before obtaining a hardship withdrawal helps to safeguard a participant’s retirement assets.

On the other hand, allowing participants who obtain a hardship withdrawal to continue contributing to the plan would allow them to enhance retirement security. They could immediately begin replacing the withdrawn funds. In addition, most plans are designed to not reinstate a deferral election following the expiration of the six-month suspension period. This increases the risk that the status quo will result in the participant effectively opting out of the plan for good.

Plan Design Simplification

In certain cases, the opportunity to simplify plan design may outweigh other objectives. For example, most plan sponsors and third-party administrators will likely embrace the opportunity to forego tracking original contributions to determine hardship withdrawal availability. The same could be true for the ability to allow withdrawals from QNECs and QMACs as well. Likewise, the ability to eliminate the six-month suspension requirement should minimize the risk of committing an operational error, which will help protect the qualified status of the plan.

Plan sponsors of 401(k) and 403(b) plans will want to be thoughtful in their approach to determining which, if any, of these new rules make sense to adopt. Like many choices, there are pros and cons to each approach.

 If you have questions, feel free to contact any one of Wipfli’s Employee Benefits experts including Tom Krieg, Steve Blom, Bob Buss, Marci Boyarski, Angie Whiteside, and Deb Teske, or talk to your Wipfli relationship executive.