Hardship Distributions
If the plan permits, participants are allowed to take a “hardship” distribution from the plan. Generally, a “hardship” distribution is described as cash withdrawal to satisfy an immediate and heavy financial need of the employee (plan participant) and is necessary to satisfy the financial need. Tax regulation 1.401(k)-(1)(d)(3)(iii)(B) specifies the following as distributions on account of an immediate and heavy financial need:
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Expenses for (or necessary to obtain) medical care that would be deductible under the Code Sec. 213(d) determined without regard to the percentage of AGI reduction (which includes expenses for the care of a spouse, dependent or primary beneficiary under the plan);
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Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments);
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Payment of tuition, related educational fees, and room and board expenses, for up to the next 12 months of post-secondary education for the employee, or the employee's spouse, children, dependents, or primary beneficiary under the plan;,
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Payments necessary to prevent the eviction of the employee from the employee's principal residence, or foreclosure on the mortgage on that residence;
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Payments for burial or funeral expenses for the employee's deceased parent, spouse, children, dependents or primary beneficiary under the plan; or
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Expenses for the repair of damage to the employee's principal residence that would qualify for the casualty deduction (determined without regard to section 165(h)(5) and whether the loss exceeds 10% of adjusted gross income).
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Expenses and losses (including loss of income) incurred by the employee on account of a disaster declared by the Federal Emergency Management Agency (FEMA) under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, Pub. L. 100-707, provided that the employee's principal residence or principal place of employment at the time of the disaster was located in an area designated by FEMA for individual assistance with respect to the disaster.
Other Distributions Required First
Reg. 1.401(k)-(1)(d)(3)(iii)(B), applicable to distributions made in plan years beginning after December 31, 2018, says that a distribution is not treated as necessary to satisfy an immediate and heavy financial need of an employee unless the employee has obtained all other currently available distributions (including distributions of ESOP dividends under section 404(k), but not hardship distributions) under the plan and all other plans of deferred compensation, whether qualified or nonqualified, maintained by the employer. In addition, for a distribution that is made on or after January 1, 2020, the employee must represent (in writing, by an electronic medium, or in such other form as may be prescribed by the Commissioner) that he or she has insufficient cash or other liquid assets to satisfy the need. The plan administrator may rely on the employee's representation unless the plan administrator has actual knowledge to the contrary.
Caution: Even though hardship withdrawals are allowed, they are still taxable distributions, and unless they meet certain exceptions, are also subject to the early withdrawal penalty. Other rules include the following:
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For plan years beginning before 2019, an employee is barred for 6 months from making elective and employee contributions to qualify as a hardship distribution. This provision was removed in the Bipartisan Budget Act of 2018 (P.L. 115-123), effective for plan years beginning after 2018.
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No hardship distributions will be eligible for rollovers. The 20% federal withholding tax requirement does not apply to hardship distributions.
Disaster Areas
In some cases an individual who took a hardship distribution to buy or build a principal residence in a designated disaster area, and the residence wasn’t purchased or constructed due to the disaster, is allowed to recontribute the amount as a rollover contribution to an eligible retirement plan. Thus, the distribution that is rolled over would not be taxable. Application of this provision comes about when Congress enacts legislation specific to a particular disaster.
SECURE 2.0 Act Section 312 provides that, under certain circumstances, employees are permitted to self-certify that they have had an event that constitutes a hardship for purposes of taking a hardship withdrawal.
Employee Certifying Deemed Hardship Distribution Conditions Were Met
This is a logical step considering the success of the coronavirus-related distribution self-certification rules and the current hardship regulations that already permit employees to self-certify that they do not have other funds available to address a hardship.
Effective Date: Plan years beginning after 2022.