In September 2019, the Internal Revenue Service (IRS) and Department of Treasury issued final regulations easing restrictions on hardship distributions from defined contribution retirement plans. While there were a number of important changes in the regulations, this blog focuses on changes regarding suspension of employees’ contributions after hardship withdrawals.
Beginning January 1, 2020, plans are prohibited from requiring suspensions on contributions for participants who take hardship withdrawals.
Background on Hardship Withdrawals
In general, retirement plan participants in 401(k), 403(b) and 457(b) plans are not allowed to receive money from their account until they separate from service with their employer or reach age 59½ .
However, the IRS allows retirement plans to let participants withdraw money before separating from service or reaching age 59½ if they have an immediate and heavy financial need. These withdrawals are called hardship distributions. Hardship distributions reduce the amount of money available to participants at retirement and can undermine the purpose of retirement accounts. To discourage the overuse of hardship withdrawals, the IRS lays out specific conditions that participants and retirement plans must meet.
Old Rule: Six-Month Suspension of Contributions
Before the September 2019 final regulations, one condition the IRS required was that participants who took a hardship withdrawal were not allowed to make further contributions to their retirement accounts until six months after the withdrawal. In other words, retirement plans had to suspend participant contributions for six months.
In practice, this had unintended consequences that further undermined the retirement security of participants making hardship withdrawals. Here’s how.
- Participants missed out on six months’ worth of contributions and on all compounded earnings that would have resulted from those contributions.
- If the plan offered matching employer contributions, participants also lost out on the match for six months and its compounded earnings.
- Because they were not contributing to their retirement plan for six months, participants became accustomed to receiving higher take-home pay. They often found it challenging to resume contributions after six months and watch their take-home pay decrease. It was less painful to delay resuming regular contributions or stop contributing altogether.
New Rule: Suspension of Contributions No Longer Allowed
The September 2019 final regulations addressed these concerns. Beginning January 1, 2020, plans can no longer require suspensions on contributions for participants who take hardship withdrawals. The IRS flipped the script from requiring suspensions to prohibiting them. This should improve participants’ retirement security and make hardship distributions easier for retirement plans to administer.
[Learn More: Defined Contribution Plans Online Course]
Other Hardship Withdrawal Changes
Besides eliminating the six-month suspension on contributions, the September 2019 hardship regulations made other changes. These include:
- Allowing plans to eliminate the requirement that participants take plan loans before a hardship distribution
- Allowing hardship withdrawals to draw on more than just participant contributions
- Revising other aspects of determining whether a hardship exists and whether a withdrawal is financially necessary.
You can learn more about these changes in the resources listed below.
- Retirement Plan FAQs Regarding Hardship Distributions—IRS, as visited October 16, 2019
- Retirement Topics—Hardship Distributions—IRS, as visited October 16, 2019
- IRS finalizes new hardship withdrawal rules—October Three, October 9, 2019
- Final Hardship Distribution Regulations, Part One: Key Changes and Deadlines for Plan Sponsors—Proskauer, September 24, 2019
- Final Hardship Distribution Regulations, Part Two: Implementation Considerations—Proskauer, September 26, 2019
Lois Gleason, CEBS
E-Learning/Online Course Instructional Designer at the International Foundation
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