If your company offers a 401k plan in your benefits package, you already know that those funds should be kept out of reach until participants reach age 59½.
There are exceptions, however. Most 401k plans allow withdrawal before retirement age in cases of financial hardship.
We’ve already seen economic impact from COVID-19, and those ripple effects are likely to continue for at least the next few years. For your plan’s 401k participants, those funds may provide a much-needed lifeline in a time of crisis.
Here’s what you need to know about the latest hardship distribution rules, including what you should do next to prepare for increased requests.
Hardship distributions are now easier
In September 2019, the IRS changed the rules around access to 401k funds during times of hardship. The final regulations allow employers a broader range of employee contribution sources and eliminate the requirement for a six-month suspension of employee contributions following receipt of a distribution. Employers are also allowed to grant a hardship distribution without first requiring employees to take a plan loan.
In short, federal rules around hardship distributions loosened up near the end of 2019, which makes it easier for you to manage access. It also means that you should ensure your plan administrator is aware of the current rules.
Current distribution requirements
Most importantly, your 401k plan must allow for hardship distributions. If your plan doesn’t currently allow for this (and most do), now is a great time to look into adding that feature.
The crux of the requirements centers around proof that the participant has “immediate and heavy financial need” for the funds they wish to withdraw. Need can still be considered immediate and heavy even if the financial hardship was undertaken voluntarily or easy to foresee.
Here are the approved uses for hardship distribution funds, if an immediate need exists (for the employee or their spouse and/or dependents):
- Medical expenses, including expenses related to COVID-19
- Expenses related to purchasing or repairing a principal residence, or costs incurred to avoid eviction or foreclosure of a principal residence
- Post-secondary education expenses, including tuition, fees, and room and board (within the first 12 months of the withdrawal)
- Funeral and burial expenses (including for the parents of employee)
- Expenses and losses incurred due to a disaster declared by FEMA
The amount a participant receives cannot exceed the dollar amount of their immediate financial need. They must inform your plan administrator in writing—including relevant proof—that they have exhausted all other plan benefit options and still lack funds.
Here are the steps you should follow prior to a plan withdrawal to ensure your company complies with current regulations.
Visit the IRS website for a complete and detailed overview of requirements. Or consult with a specialized 401k audit firm or accountant. At Cassell Plan Audits, we’re always happy to answer your questions!
Here’s what to do next
Review the features of your 401k plan to be sure you know whether hardship distributions are currently allowed. If they aren’t, consider adding that option sooner, rather than later.
If you rely on a third-party administrator to process hardship distributions on your behalf, check to be sure those services are in place before an urgent need arises. If you process these distributions directly, take time now to review the regulations and make sure you have a clear plan for handling requests.
Finally, under no circumstances should hardship distributions be actively encouraged. While the CARES act has waived the 10% penalty on early withdrawal, participants must still pay income tax on that money (spread out over three years). Reallocating funds set aside for retirement is a big decision and shouldn’t be taken lightly.
Still have questions? We’ve got answers! Contact us today for more information and to schedule your virtual appointment with Cassell Plan Audits at 630.886.7669.
