Employers that offer a 401(k) plan should generally encourage participants to invest as much as they can and not touch the money until retirement. However, there may be instances when employees feel they need to access their plan funds before reaching retirement age.
In some of those cases, participants may qualify for a 401(k) hardship distribution. These differ from plan loans in that hardship distributions don’t need to be repaid — though they’re still subject to income taxes and a 10% penalty if under the age of 59½. Plan administrators must approve a hardship distribution under the current standard.
The previous standard
Generally, for distributions made before 2020, plans could use either of two standards for determining whether a hardship distribution was necessary: a safe-harbor standard or a non–safe-harbor standard. The safe-harbor standard:
The non–safe-harbor standard was nominally a determination based on all relevant facts and circumstances. However, IRS regulations allowed an employer to rely on a participant’s representation that the emergency financial need couldn’t reasonably be met by certain specified means — such as liquidation of assets, loans and other plan distributions. Approval was also contingent on the plan sponsor having no contrary knowledge of the participant’s ability to pay.
The current rules
For distributions made on or after January 1, 2020, there’s only one relatively simple standard. It imposes two requirements to establish that a distribution is necessary:
Cash and other liquid assets aren’t “reasonably available” if they’re earmarked for payment of another obligation in the near future, such as rent or a mortgage. A plan administrator can’t accept an employee’s representation if the administrator has actual knowledge contrary to the representation.
Additional conditions
A 401(k) plan can impose only the minimum conditions described above or it can impose additional conditions if, for example, the plan sponsor is particularly concerned about preserving accounts solely for retirement. Additional conditions could include requiring that employees first take all nontaxable loans available under the employer’s plans.
For distributions made on or after January 1, 2020, however, additional conditions can’t include a required suspension of elective contributions or employee after-tax contributions under the rules for qualified plans — which include 401(k)s — and certain other retirement plans.
Administrative challenges
There’s no doubt that 401(k) plans are a valuable employee benefit that can help attract and retain employees. However, one of their challenges is managing the administrative requirements, including the current standard for hardship distributions. Contact us for help understanding all the tax and information-reporting rules applicable to retirement benefits.
If you have any questions about the content of this publication, or if you would like more information about HoganTaylor's Employee Benefit Plans practice, please contact Gwen Mazzola, Employee Benefit Plans Practice Lead.
INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.