Hardship Rules Today (FAQ)

The hardship withdrawal rules have changed dramatically in recent years. The below FAQ addresses questions and answers based on the rules that are applicable now, in 2020. 

What is a hardship distribution?

A hardship distribution is an optional triggering event a plan sponsor can make available to plan participants who are still employed. Hardship withdrawals can be permitted in profit sharing, 401(k) and 403(b) plans. They are not permitted in pension plans, liked defined benefit plans and money purchase pension plans. If permitted by the plan, a participant experiencing an “immediate and heavy financial need” can take a distribution from their retirement plan balance of an amount necessary to satisfy their need. The expenses must be incurred by the participant, or in some cases the participant’s spouse, dependents, or primary beneficiary (if permitted by the plan).

In what situations is a need considered immediate and heavy?

Whether a need is immediate and heavy depends on the facts and circumstances of the situation. Many plans limit hardship withdrawals to specific reasons that are deemed to be immediate and heavy according to the regulations. By doing so, the employer does not need to review the facts and circumstances of the situation and make the decision as to whether it will qualify. For example, purchasing a boat is not an immediate and heavy financial need.

A distribution is not considered necessary to satisfy an immediate and heavy financial need if the employee has other resources available to satisfy the need.  This would include the ability to take another form of distribution from the plan. A plan may require an employee to take a loan first before qualifying for a hardship distribution, but this is no longer a requirement under the final regulations.

What expenses are deemed to be immediate and heavy?

Each plan can define the rules for a participant to take a hardship withdrawal, but most plans will limit the availability of a hardship withdrawal to the following “safe harbor” reasons:

  1. Medical expenses
  2. Purchase of a principal residence
  3. Tuition and related educational fees and expenses
  4. Prevention of eviction or foreclosure
  5. Burial or funeral expenses
  6. Expenses to repair damage of a principal residence due to casualty loss
  7. Expenses or loss incurred by a participant due to a federally declared disaster

How does the employer determine if a hardship withdrawal is necessary to satisfy a need?

The final regulations have a new standard for the employer to follow when determining if a withdrawal from the plan is necessary to satisfy a financial need.

  • The withdrawal cannot exceed the amount of the need, except to cover the reasonably anticipated federal, state, or local income taxes and penalties that will apply.
  • The employee must first obtain any available in-service distributions from this plan, and any other deferred compensation plan maintained by the employer.
  • The employee must represent to the employer that they have insufficient cash or liquid assets “reasonably available” to satisfy their need. The regulations indicate that cash or other assets earmarked for another expense, such as rent, are not considered reasonably available.

The plan administrator may rely on the participant’s representation unless they have actual knowledge to the contrary. The plan administrator is not required to go looking for information to the contrary.

Must the plan administrator collect documentation to substantiate the expense?

Before approving a hardship distribution, the plan administrator will need to collect and review documentation that supports the request. This could be an actual invoice or other documentation reflecting the amount that must be paid, or it could be a summary of relevant information to substantiate the expense. If the plan is ever under audit, the IRS may request documentation to support a hardship distribution. The documentation must substantiate an expense that qualifies for hardship, who the expense was for, and the amount of the expense. If the plan administrator only had a summary of information to substantiate the request, and not full documentation, the participant will be required to provide this at the time of request. The plan administrator may prefer to require the full documentation up front, so they are prepared in the event of an audit.

What amounts can the participant take from the plan in the event of a hardship?

The regulations now permit any amount in a 401(k) plan to be available prior to age 59-1/2 for a hardship withdrawal, however, this may be limited by the plan document. It is not uncommon that hardship withdrawals are limited to employee elective deferral sources, but employer contributions (including safe harbor amounts) can be made available as well.

In a 403(b) plan, assets are more restricted. Earnings on elective deferrals amounts are not available. In addition, QNECs and QMACs (including safe harbor contributions) are not available from a 403(b)(7) custodial account (invested in mutual funds) but are available from a 403(b) plan that is invested in annuity contracts.  

Can a participant continue to defer into the plan following a hardship withdrawal?

Yes. A deferral suspension period is no longer permitted following a hardship withdrawal. If the participant would like to continue to defer into the plan, they may do so.

Are there any consequences to the participant when they take a hardship withdrawal?

A hardship withdrawal is subject to income taxes, just like any other retirement plan distribution would be. Amounts that reflect basis, or after-tax contributions, are not taxable when distributed. However, tax withholding is not required since the distribution is not eligible for rollover treatment. 10 percent will generally be withheld, unless the participant waives this.

The participant will incur a 10 percent early distribution penalty tax if they are under age 59-1/2 and do not qualify for a penalty exception.

The participant can “gross-up” their distribution by an amount reasonably expected to cover their anticipated taxes and penalty.                                                                                                                                        

“Post-PPA” Cycle 3 Restatements for Defined Contribution Plans

Retirement plan documents are legal documents that outline a plan’s provisions and the regulatory requirements for the plan. Most qualified plans use what is known as a “preapproved” plan document. This is one the IRS has reviewed and approved for use. Alternatively, a plan can use an attorney-drafted document (known as an individually designed plan document).

What is a restatement?

Preapproved plan documents are required to be rewritten, approved by the IRS, and adopted by plan sponsors every six years. This process is known as a restatement and it allows the document language to be updated for legislative changes and amendments that occurred since the last document was written. The IRS has separate cycles for defined contribution plans, defined benefit plans, and 403(b) plans. The defined benefit restatement window was just closed on July 31, 2020, with the restatement window for defined contribution plans beginning on its heels. This window opened on August 1, 2020. This restatement is being referred to as the “Cycle 3 restatement” or the “post-PPA restatement.”

What types of retirement plans are included?

The defined contribution plan restatement includes all preapproved plan documents for profit sharing, 401(k), and money purchase plans. In addition, some ESOP and church 401(k) plans may be able to use a preapproved plan for the first time with this restatement. Plans that currently use an individually designed plan may also choose to adopt a pre-approved plan during this cycle.

In the past, the IRS had two preapproved document programs available: prototype and volume submitter. Those programs have gone away with this restatement cycle. In their place is one IRS preapproved plan program that incorporates the options of both programs.

When will this restatement take place?

Document providers are working now to prepare their newly approved documents for adoption by employers. Once they are ready for use, service providers can begin the process of restating plan documents to a preapproved post-PPA document for their clients. The deadline for plans to be restated under Cycle 3 is July 31, 2022. As a result, most plans will likely be restated, or at least begin the process, sometime in 2021.

DOL Electronic Disclosure Rules

New Electronic Disclosure Rules from the DOL

The Department of Labor (DOL) released a final rule on electronic disclosure of retirement plan notices to plan participants on May 21, 2020. This new rule will allow disclosures to be delivered to certain employees via email or posted on a web site, as a default, rather than by election.


Plans covered by ERISA must provide multiple notices to participants and beneficiaries each year. In the past, the notices had to be hand-delivered or mailed to participants, unless the participant provided consent to receive the notice electronically or the plan was able to meet a stringent safe harbor requirement for electronic delivery. As a result, many employers chose to mail notices, despite the cost of doing so, to ensure they were meeting their fiduciary requirements.

New Safe Harbor

Although the old rules have not gone away, the new rule adds availability for electronic disclosure for many businesses that could not easily satisfy the requirements in the past. The new rule adds a safe harbor option that can be followed (at the employer’s option) to provide disclosures through electronic means without consent, unless the participant requests a paper copy of the disclosure. The new safe harbor will permit the employer to post the disclosure to a website or furnish it through email delivery.

Covered Individuals and Covered Documents

The new safe harbor is available only for “covered individuals.” A covered individual is any person entitled to receive a “covered document” who has a valid email address or smartphone number. This can be an email address or phone number that the employee provides to the employer, or one that the employer assigns to the employee for employment-related purposes (but not solely for purposes of receiving these communications). Therefore, if the employee has an email address assigned to them for business purposes, this email address can be used to deliver covered documents as required under ERISA. A covered document is any document required to be provided to a participant, beneficiary, or another party under ERISA, except for one that is only required to be provided upon request.

Initial Notice

Before any disclosures can be provided under the new rule, an initial notification must be provided, on paper, to inform participants they will be receiving notifications electronically, and must include:

  • how the disclosures will be delivered (email, website, etc.) along with any instructions needed to access the disclosures, and
  • that this is a change for existing participants (when this method of delivery is first used), and
  • that they have a right to opt out of electronic delivery if they prefer to receive the notice on paper, at no charge.

Notice of Internet Availability

Once an initial notice has been provided, a Notice of Internet Availability (NOIA) must be provided whenever a new notice is posted to a website to let the participants know it is available. Alternatively, the disclosure can be attached to the email, or just included in the body of the email.

The NOIA is intended to be short and concise. It must identify or describe the covered document, how to access it, and the participant’s right to receive a paper copy and opt out of electronic delivery. To avoid “notice overload,” the DOL allows one NOIA to be used to announce multiple disclosures that are posted at the same time. Documents that can be combined under one notice include the SPD, any covered document that must be provided annually (as opposed to upon the occurrence of an event) like participant-level fee disclosure, and any other documents not specifically included but otherwise authorized by the DOL or IRS. However, note that the new rule does not change the deadline for providing any specific notice or disclosure.

If posted online, the covered documents must be available until replaced by a newer version, but at a minimum for at least one year. If a newer version is posted sooner than the one-year period has expired, both documents will be accessible at once.

Invalid Addresses

The plan administrator must ensure that they will receive notifications of invalid addresses so that they can review and correct the problem. If they cannot obtain a valid electronic address, they must treat the participant as having opted out. Also, the plan administrator must take steps upon an employee’s termination to ensure the continued accuracy of the participant’s electronic address.

Effective Date of the New Rule The final rule becomes effective on July 27, 2020, 60 days after published in the Federal Register. However, the DOL has indicated they will not take any enforcement action against a plan administrator that relies on this safe harbor before that date. Their decision to provide this non-enforcement policy supports the government’s broader effort to respond to the COVID-19 pandemic.

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SECURE Act – Tax Credit

SECURE Act New Plan Federal Tax Credit for Small Employers

Effective in 2020, a federal tax credit is available for each of the first three years of a new retirement plan. There is a separate credit for 401(k) plans that add an eligible automatic contribution arrangement. These credits are available to employers with no more than 100 employees earning $5,000 or more annually.

Part I – Start up Credit

The start-up credit is one-half of the costs paid by the employer to set-up and administer a new plan. It can be as much as $5,000 per year but is limited to $250 per non-highly compensated employee covered by the plan.

              Year                Estimated Number of NHCEs           Estimated Fees Paid by Employer        Start-up Credit Amount
202010$ 1,800$  900
20218 2,200 1,100
202210 2,500 1,250

Part II – Eligible Automatic Contribution Arrangement (EACA)

This $500 tax credit is available in each of the first three years a plan offers an EACA. EACAs require the employer to automatically enroll eligible employees at a uniform contribution rate (3% of pay is commonly used) and provide an annual notice to employees. Employees may opt out of contributing. This credit is available whether plan expenses are paid by the employer or the plan itself.

            Year                EACA in Plan?              EACA Credit Amount      
2020No$                  –
2021Yes 500
2022Yes 500

Summary – Total Estimated Tax Credit Available in First Three Plan Years

          Year                                      Total Credit
2020$   900
2021 1,600
2022  1,750
Total$  4,250

Please consult with your tax accountant. The tax credit is claimed by filing IRS Form 8881 with your business income tax return. It is recommended a separate expense category is used in your general ledger for retirement plan expenses so your accountant can easily identify the actual expenses paid.

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