Guide to the proposed hardship withdrawal regulations

Vanguard Regulatory Brief

A guide to the proposed hardship withdrawal regulations

Strategic Retirement Consulting | February 2019

Vanguard Regulatory Briefs provide clients with general information on recent developments affecting employee retirement plans. We want to share key aspects of the proposed regulations and considerations for plan sponsors like you, as you implement the provisions into your plan.

The Bipartisan Budget Act of 2018 (BBA) changed some of the rules for hardship withdrawals. The Internal Revenue Service (IRS) also released proposed hardship withdrawal regulations with additional provisions. Hardship withdrawals are an important plan feature designed to support a participant with an immediate financial need, and the IRS regulations outline the compliance requirements.

IRS clarification and expansion of BBA-proposed changes

The IRS-proposed regulations clarified the following BBA provisions:

Six-month suspension

Effective January 1, 2020, a plan may no longer prohibit a participant from making elective contributions to the plan for any length of time after taking a hardship withdrawal. Most Vanguard-administered plans eliminated the suspension effective January 1, 2019. While plans have the option to require a suspension in 2019, it must be removed on or before January 1, 2020. Existing suspensions in effect at the time of the change may be eliminated or continued for the remainder of the suspension period.

Note for plan sponsors: Although the proposed hardship regulations do not mention nonqualified plans, it seems reasonable that the elimination of the suspension would apply to all of an employer's plans, including nonqualified plans. However, it is recommended that the current language in the nonqualified plans be reviewed to determine whether any changes are needed in light of the new rules.

Special note for Puerto Rico plans: The 12-month suspension applicable to residents of Puerto Rico that participate in a solely qualified or dual-qualified Puerto Rico plan must be retained because these plans are governed by the laws and regulations in Puerto Rico.

Loan requirement A participant is not required to take a loan before taking a hardship withdrawal; however, a plan still has the option to require a participant to do so. Please note that although a loan is not required, all other available withdrawals must be taken before a hardship withdrawal.

Note for plan sponsors: Most Vanguard-administered plans have already eliminated this loan requirement, but some plans will continue to require a loan in an effort to mitigate leakage.

QNEC/QMAC and earnings on elective deferrals A plan may include qualified nonelective contributions (QNEC), qualified matching contributions (QMAC), and earnings on elective deferrals in the available hardship withdrawal amount. The IRS clarified that safe harbor contributions made under a qualified automatic contribution arrangement (QACA) may be included for hardship withdrawals.

Note for plan sponsors: The proposed regulations do not comment on the inclusion of employer contributions under traditional safe harbor designs. However, it seems reasonable that the IRS will include all safe harbor contributions when the regulations are finalized. Most Vanguard-administered plans have added the earnings on elective deferrals to the available hardship withdrawal amount but not the QNEC/QMAC. In general, Vanguard has observed that many plan sponsors are comfortable allowing a participant to access elective deferrals and earnings for a financial emergency but believe that employer contributions should be preserved for retirement.

Special note for 403(b) plans: These plans may not permit earnings on elective deferrals to be available for hardship withdrawals. Additionally, the QNEC/QMAC availability is only for noncustodial 403(b) annuity plans. QNECs and QMACs in a 403(b) plan that are in a 403(b)(7) custodial account continue to be ineligible for hardship withdrawals.

Additional provisions

The IRS's proposed regulations also address a number of additional provisions including disaster relief, a new standard for determining need using participant representation, and beneficiary expenses.

Casualty loss

The Tax Cuts and Jobs Act of 2017 (TCJA) limited casualty deductions to losses resulting from federally declared disasters. This means that hardship distributions to pay for damage to a principal residence are limited to situations where the damage was caused by a federally declared disaster. The IRS-proposed regulations clarify that a hardship distribution may be made for expenses incurred to repair damage to the participant's principal residence even if the loss was not attributable to a federally declared disaster. This interpretation is retroactively effective as of January 1, 2018, the TCJA effective date.

Note for plan sponsors: This was an expected clarification from the IRS that impacts both plans that did and did not apply the TJCA casualty loss definition.

? Plans that did not apply TJCA: The majority of plans continued to operate without requiring a federally declared disaster for a casualty loss. These plans should simply confirm that the plan's language supports this administrative practice and only amend if needed.

? Plans that did apply TJCA: These plans may need to be amended to reflect the administrative practice used in 2018 under TJCA and the future administrative practice following the regulations.

New safe harbor disaster reason

The list of safe harbor reasons is expanded to include expenses incurred by the employee due to a Federal Emergency Management Agency (FEMA) declared disaster if the employee's principal residence or place of employment is located in the disaster area. Eligible expenses may include items such as food, fuel, shelter, and loss of income. This new safe harbor reason may be applied to losses resulting from disasters that occur on or after January 1, 2018.

In addition, the IRS specifically provided relief for Hurricanes Florence and Michael that is consistent with Announcement 2017-15 (which covered Hurricane Maria and the 2017 California wildfires). The relief is slightly broader than the new safe harbor disaster reason but does have a March 15, 2019, expiration date.

Note for plan sponsors: Adopting the new FEMA disaster reason is optional. However, it is recommended as a best practice for the typical plan sponsor. The industry has sought this "evergreen" disaster hardship reason to eliminate delays in providing immediate support for impacted participants. The vast majority of plans already utilize the current six IRS safe harbor hardship reasons and we expect most will add the new FEMA disaster reason.

A new standard for determining need using participant representation

For participants receiving hardship withdrawals, the current rules provide that either a safe harbor method or a facts and circumstances method can be used for determining whether the distribution is necessary to satisfy the financial need. The proposed regulations remove both of these methods and instead provide a single general standard for determining if the amount of the hardship distribution is necessary to satisfy the financial need.

The new standard requires that:

? The amount of the hardship cannot exceed the amount of the need (grossed up for taxes).

? All other available distributions under all plans of the employer must be taken first (including company stock dividends, if applicable).

? The employee must represent, in writing or electronically, that he or she has insufficient cash or other liquid assets to satisfy the need. The plan administrator may rely on the employee's representation unless they have actual knowledge to the contrary. Because of the lateness in issuing the regulations, the requirement to obtain this representation does not begin to apply until distributions are made on and after January 1, 2020.

Note for plan sponsors: Moving to one streamlined standard will simplify administration and ensure compliance with the IRS requirements.

Beneficiary expenses The proposed regulations clarify that a participant may request a hardship withdrawal for eligible expenses incurred by, or on behalf of, the participant's primary beneficiary as designated under the retirement plan. The eligible expenses are limited to the following safe harbor hardship reasons: medical, post-secondary education, and funeral expenses of a deceased primary beneficiary.

Note for plan sponsors: The purpose of incorporating this provision into the proposed regulations is to align the Treasury Regulations with the Pension Protection Act, which included the beneficiary hardship provision in 2006. Given that plan sponsors have been aware of the ability to offer hardship distributions for primary beneficiaries for more than a decade, it is likely the plans that wish to adopt the provision will have already done so. From a practical perspective, a participant's beneficiary is often a dependent and therefore may already be eligible for a hardship withdrawal.

Vanguard is here to help you with implementation

It's important to remember that these regulations have been released in proposed form and are not yet finalized. Vanguard is participating in discussions with our industry groups and helped inform comment letters submitted to the IRS in January. We expect the IRS to provide clarification on several issues, including:

Proposed regulations Reliance on the proposed regulations was not specifically included in the guidance, however it seems unlikely that the IRS would pursue enforcement efforts for plans using a good faith reasonable approach to comply. The IRS accepted comments in January and plans to issue final regulations. In the interim, plan sponsors will need to assess the risks and benefits of proceeding without final guidance.

Amendments

The preamble to the proposed regulations provides that the Treasury Department and IRS expect that plans will need to amend their hardship distribution provisions to reflect some or all of the changes in the proposed regulations. Generally, the deadline for amending a plan to reflect a change in qualification requirements is the end of the second calendar year that begins after the issuance of the Required Amendments List. Thus, it appears that plan amendments may not be required until 2021, at the earliest. The final regulations are expected to provide additional information regarding the timing of amendments.

Preapproved documents

The proposed regulations did not reference the timing of amendments for preapproved plan documents. For plan sponsors using Vanguard's preapproved plan documents, we will contact you with more information regarding plan amendments once additional IRS guidance is received.

Administration

? Implementation of BBA changes: Plan administration has already been aligned with plan sponsor elections made in late 2018. To the extent you wish to change your elections with regard to these provisions, please contact your Vanguard relationship representative.

? Implementation of additional provisions outlined in the proposed regulations: Vanguard is in the process of evaluating and preparing our systems and procedures to accommodate the new hardship withdrawal provisions. For example, we will add a FEMA disaster hardship reason into our administrative process and ensure our systems include the required participant representations. Until those changes are made, we will continue to administer plans using the current hardship rules and will keep plan sponsors apprised of our progress and next steps.

Your Vanguard relationship representative is ready to help you.

Please contact your Vanguard relationship representative if you have any questions or comments concerning the information discussed in the Vanguard Regulatory Brief.

Connect with Vanguard? > institutional.

Vanguard Regulatory Briefs should not be considered legal advice on specific legal issues or a substitute for legal counsel.

Institutional Investor Group P.O. Box 2900 Valley Forge, PA 19482-2900

? 2019 The Vanguard Group, Inc. All rights reserved. SRCHSP 022019

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download