An Insider’s Look at Hardship Withdrawals

It isn’t easy to take money from a retirement plan account, and there are specific criteria regarding under what circumstances and how that can take place. In a session of the recent 2020 NTSA Summit, Emily Oglesby, Advanced Markets Consultant, Technical Services for Voya Financial, offered an insider’s view and insights on such withdrawals.

In the past, Oglesby observed, a plan had two methods by which to determine whether a participant’s request for a hardship distribution could be granted: a facts-and-circumstances test, or a safe harbor requiring that an employee take all available non-taxable loans before a distribution can take place. If it used the safe harbor, all employee contributions had to stop for the six months after the withdrawal took place.

The rules for hardship withdrawals have changed, Oglesby noted, with the enactment of the Tax Cuts and Jobs Act in 2017 and the Bipartisan Budget Act in 2018, as well as the Treasury’s issuance of hardship regulations.

Now the facts-and-circumstances test is eliminated. “This sort of tracks with common sense,” said Oglesby. So only the safe harbor is available as a tool by which to determine if a hardship withdrawal can take place. In addition, there no longer is a requirement that a participant take a loan first before a withdrawal can take place, nor can an employee be prevented from making contributions to their accounts for six months after a distribution is made. However, Oglesby noted, while a plan is no longer required to stipulate that a loan must precede a distribution, it can choose to set such a requirement. “It’s still an option,” she said.

Under Treas. Reg. §1.401(k)-1(d)(3)(ii)(B)(6), expenses for the repair of damage to the employee’s principal residence that would qualify for the casualty deduction under Code Section 165 and whether the loss exceeds 10% of adjusted gross income. In addition, that guidance creates a Federal Emergency Management (FEMA) safe harbor that covers losses and expenses that are due to a federally declared disaster.

Discussion also arose concerning whether adoption expenses would be another safe harbor for withdrawals. “We’ll have to wait and see,” said Oglesby, adding, “I think there are a lot of questions about it.” Session moderator Susan Diehl noted that already it is necessary that a parent’s name and a child’s tax identification number must be reported on a tax form, but that payors don’t know how to adjust their systems. “I think Emily’s right,” she said, agreeing that there are many questions to be answered.