New hardship withdrawal guidance makes 401(k) accounts more accessible for participants experiencing financial distress. The changes are intended to make rules more flexible for those under severe financial strain and in immediate need of relief.
Previously, if a participant took a hardship distribution, ongoing 401(k) contributions were not allowed for six months after a withdrawal; new rules eliminate this six-month suspension entirely for withdrawals made on or after January 1, 2020. Plan sponsors have the option to adopt the new requirement immediately or wait until the 2020 implementation date.
“This adjustment will allow participants to continue their 401(k) contributions, and it lessens the responsibilities for the plan sponsor to track and enforce the previously standard six-month suspension on contributions following a hardship withdrawal,” Katie Kirchner, vice president of client services at Bukaty’s Financial Services division, said.
Previously, participants could only withdraw personal contributions, but not the earnings on those contributions. The new rule permits participants to have access to both contributions and earnings. Additionally, certain employer contribution types that were previously unavailable for distribution are now permitted to be withdrawn.
Under the new rules, participants are no longer required to take a loan against their 401(k) savings, which must be repaid, prior to utilizing a hardship distribution. The rule also relaxes plan sponsor hardship-verification requirements. Now a participant’s written representations of financial need and lack of resources is sufficient to certify a hardship withdrawal. This contrasts with previous requirements, which placed the burden of certification on the plan sponsor. Despite the updated guidance, it is recommended that employers keep documentation verifying the expense in case of an audit.
Finally, in the case of a federally declared disaster, 401(k) plan participants are no longer required to wait for the IRS to issue specific hardship guidelines for that disaster; instead, participants are now allowed to get an immediate hardship distribution.
As a reminder, hardship distributions are still taxable and if the participant is under 59 and a half years of age, the distribution is also subject to a 10% penalty fee. While hardship withdrawals are more accessible, 401(k) participants are still advised to have an emergency fund to avoid tapping future retirement savings.
For plan sponsors, we recommend proactively examining and adjusting necessary documents to reflect the changes.
“Plan sponsors need to talk to their document provider to ensure documents are up to date with their desired hardship distribution policy changes,” Katie Kirchner said. “The deadline for these document changes is the end of the year; however, sponsors are permitted to act under their new rules prior to this deadline.”
