IRS regulations allow, but don’t require, retirement plan sponsors to permit participants to make hardship distributions from their elective deferral accounts under certain circumstances.
Specifically, the participant must be facing an immediate and heavy financial need and unable to reasonably obtain the money from another source. Also, the distribution cannot exceed the amount necessary to satisfy this need, plus the payment of any taxes resulting from the distribution.
Unless there is evidence to the contrary, employers can rely on an employee’s written statement that his or her need cannot be met from another source of funds. If an employer has knowledge that the participant’s need would not qualify for a hardship, though, it cannot authorize the hardship withdrawal.
Under an IRS safe harbor, employees can automatically be considered to have an immediate and heavy financial need if the distribution is for one of the following purposes:
- Healthcare expenses for the employee or his or her spouse, dependents or beneficiary.
- The purchase of a principal residence.
- Postsecondary education expenses (including tuition and room and board) over the following 12 months.
- To prevent eviction from a principal residence or mortgage foreclosure on the residence.
- Funeral expenses for the employee or his or her spouse, dependents or beneficiary.
- To repair certain types of damage to a principal residence.
Important: Previously, plan sponsors could suspend participants from making elective deferrals for six months after taking a hardship distribution. Recent amendments to the hardship distribution regulations removed this restriction as of January 1, 2020 and it is no longer allowed. Participants should continue to make elective deferrals after they take a hardship distribution.
It's important to make sure your payroll department is aware of this change, so they don’t stop elective deferrals after a hardship is processed. We are here to help and answer questions.