With Thanksgiving on the horizon, now is the time to check on end of year changes for compliance for your 401(k), 403(b) and other defined contribution pension plans. The IRS has just issued proposed regulations (“Proposed Regs”) for 401(k) and 403(b) plans that can be used for planning and changes for 2019 and 2020. Not all changes are required; optional ones can have effective dates selected by the employer. Careful analysis can help employers to determine which changes to adopt and when. The following is a summary of changes to consider.
Hardship Distributions
The Bipartisan Budget Act of 2018 ("Budget Act") made a number of changes starting January 1, 2019 (with formal plan amendments by December 31, 2019) and later. The Proposed Regulations intend to implement the Budget Act and Tax Cuts and Jobs Act ("TCJA") changes.
The Proposed Regs clarify that suspending employee deferrals and contributions for 6 months after a hardship withdrawal is taken will no longer be permitted. Because of the timing of the Proposed Regs, this change will be effective as of January 1, 2020 but can be made effective (by amendment) as early as January 1, 2019. In addition, a plan amendment may remove suspensions as of January 1, 2019 that began in 2018.
Your defined contribution plan can also:
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Eliminate any requirement that a participant take all nontaxable plan loans before taking any hardship withdrawal.
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Expand the access for 401(k) plan hardship withdrawals to all earnings on pre-tax deferrals by eliminating the December 31, 1988 limitation; this does not apply to 403(b) plans.
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Expand the access for hardship withdrawals to QNEC and QMAC account balances; for 403(b) plans, this does not apply to QNECs and QMACs in custodial accounts.
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Treat the “primary beneficiary” under the plan the same as a spouse or dependent with qualifying medical, educational or funeral expenses for a hardship withdrawal.
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Treat casualty losses for damage to a principal residence without regard to the new restrictions in Code Section 165 removing the individual tax deduction and without the 10% early distribution penalty.
New General Standard for Hardship Withdrawals
The Proposed Regs also revise the general standards for qualifying for a hardship withdrawal to require:
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The amount of the distribution cannot exceed the financial need, including any taxes and penalties reasonably expected to result from the distribution;
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The employee must have obtained other available distributions from the employer’s plans, other than a nontaxable loan; and
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Starting January 1, 2020, the employee must represent that the employee has insufficient cash or other liquid assets to satisfy the financial need.
The Proposed Regs also add to the reasons for a hardship withdrawal under the "safe harbor" by including expenses and losses on account of a federally declared disaster located in the area of the employee’s principal residence or principal place of employment. Issuing relief for each disaster as it occurs will not be necessary. The Proposed Regulations recognize disaster relief for Hurricanes Florence and Michael through March 18, 2019.
Other Plan Changes
Safe harbor plans can be amended to allow employers to use forfeitures to fund safe harbor contributions if the plan is amended by the end of the year (December 31, 2018 for 2018 calendar year plans).
Rollover contributions can allow a participant to rollover a federal tax levy that the IRS has returned to the participant. This can be effective as of January 1, 2018 or later. It is not a common occurrence and may be too administratively cumbersome for many plans.
Disaster relief for hurricanes and wildfires has been issued by the IRS over the last two years that has permitted expanded in-service withdrawals, loans and easing of distribution penalties. Employers should confirm with their plan administrators if any relief has been used and, if so, which provisions and which disasters so that specific plan amendments can timely reflect use of these exceptions. 2017 disasters need plan amendments by December 31, 2018; 2018 disasters need plan amendments by December 31, 2019.
Updating Tax Effects Notice
Under Code Section 402(f), plans have been required to provide a tax effects notice to any participant receiving an eligible rollover. This notice applies to 401(k), 401(a), 403(b) and 457(b) plans. The IRS last issued model notices in 2014. Updated notcies are now in IRS Notice 2018-74. While many employers use the IRS models, many employers also modify the model notices to better reflect their plans and to eliminate portions that do not apply to their plans. If your plan administrator has not provided updated notices, now is the time to ask for them or to work on customized notices.
Employers are encouraged to consult with their counsel to determine which changes to make in their plans. Employers using prototype and volume submitter plans should ask providers about amendments to their adoption agreements.
