The IRS has issued new rules that will expand employees’ access to their 401(k) funds in cases of financial hardship. Unlike loans, hardship withdrawals are not repaid to the plan with interest, so they permanently reduce the employee’s account balance. Hardship withdrawals also are subject to income tax and, if participants are younger than age 59½, a 10 percent early withdrawal penalty. For these reasons, employees facing financial hardship should consult their tax accountant and consider these withdrawals as a last-ditch option.
These changes eliminate the suspension period that barred participants who take a hardship distribution from making new contributions to the plan for six months. Eliminating the contribution suspension could have a mixed effect on leakage from 401(k) plans by encouraging more hardship withdrawals, but this could be offset by letting those who take distributions rebuild their savings sooner. Some employees were not continuing to save for their retirement even after their six-month suspension was over and missed out on the company match.
The new rule also removes the requirement that participants first take a plan loan, if available, before making a hardship withdrawal. But unlike the elimination of the six-month suspension period, this change is not mandatory, so plan administrators may continue to require participants to take a plan loan before being eligible for a hardship withdrawal to cut down on leakage.
Instead of requiring plan administrators to take into account all relevant facts and circumstances to determine if a hardship withdrawal is necessary, these new regulations require only that a hardship distribution not exceed what an employee needs and that employees certify that they lack enough cash to meet their financial needs. Plan administrators can rely on that certification unless they have knowledge to the contrary.
The new rule also allows participants to access employer matching contributions, employer nonelective contributions such as profit sharing and investment earnings for hardship distributions, in addition to employee contributions. Previous rules only allowed participants to tap their own contributions to the plan.
If you have any questions about how the new IRS 401K hardship rules will impact your company’s 401K plan or your ability to make deductions from it, please contact your tax accountant in Springfield Missouri at Schultz, Wood, & Rapp.