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Retirement Plan Participants Reap Some Benefit From Tax Reform

October 29, 2018Articles For Your Benefit

After a long period of relative stability enjoyed by sponsors of qualified retirement plans, several significant modifications have been made by the Bipartisan Budget Act of 2018 (Act). This legislation follows closely on the heels of changes enacted by the Tax Cuts and Jobs Act of 2017 (Tax Cuts Act), which affected hardship withdrawal from 401(k) plans in particular. Effective for plan years beginning after December 31, 2018, the Act substantially liberalizes the restrictions on a participant’s access to his or her account in order to address financial hardship.

First, the regulations previously required that a participant be prohibited from making elective deferral contributions for a period of six months following a hardship withdrawal. The Act removes that six-month suspension requirement, allowing participants to resume deferral contributions immediately after receiving a hardship withdrawal.

Second, a participant may receive a hardship distribution without first taking any available loan under the plan. A participant, of course, must establish financial need and show that other options have been exhausted, but that no longer includes the requirement that the participant first seek the maximum plan loan available.

Third, participants now may access qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs), in addition to elective deferral contributions, in the event of hardship, as well as earnings on all three types of contributions. Traditionally, hardship distributions were limited to the aggregate of the participant’s own deferrals.

While these changes provide welcome relief to many participants, an earlier change effected by the Tax Cuts Act narrows, slightly, the circumstances under which a participant may request a hardship withdrawal. Under the 401(k) regulations, hardship withdrawal is available only to satisfy an immediate and heavy financial need. Such a need may be established through a facts and circumstances analysis, but most plans rely upon the six safe harbor needs recognized in the regulations, one of which is casualty damage to the participant’s principal residence. The Tax Cuts Act modified Code Section 165(h) to limit casualty loss deductions for tax years 2018 through 2025 to those occurring in a federally declared disaster area. As a result, for those 401(k) plans that rely on the safe harbors, hardship withdrawal will be available for casualty losses only when those losses are sustained in federally declared disaster area.

Apart from the statutory changes affecting hardship withdrawal, the Tax Cuts Act extends the deadline for rolling over plan offset amounts until the participant’s tax filing deadline, including extensions. This applies when a participant separates from service (or a plan terminates), and the unpaid balance of an outstanding plan loan is reported as a deemed distribution. The participant now may repay the loan balance to the original plan for purposes of effectuating a direct rollover or may use other funds to contribute as a rollover to an IRA (or another qualified plan) by that extended deadline. Previously, the deadline to effectuate the rollover was the 60th day after the loan offset. The change applies to plan years beginning after December 31, 2017.