Answers to Common

Questions Regarding

DistributionsRobert M. Richter, J.D., LL.M.

Retirement Education Counsel

What We’ll Cover

• Hardships

• QDROs

• Participant Loans (if time permits)

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HARDSHIPS

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The Bipartisan Budget Act of 2018

• Directed Treasury and IRS to eliminate the

6-month suspension period and the

requirement that a plan loan be obtained

• Expanded the available sources (optional)

– Earnings on deferrals, QNECs, QMACs, SHs

403(b) Plans

• Limitations still apply to §403(b)

arrangements

– Income attributable to elective deferrals

cannot be withdrawn for a hardship

– QNECs and QMACs in custodial accounts are

ineligible for hardship distributions

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Proposed Regulations

• 6-month suspension of elective deferrals

or after-tax contributions no longer

permitted

– Can wait until 1/1/2020 to implement

– Permits elimination of suspensions as of

1/1/2019 for hardships made in 2018

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Proposed Regulations• Eliminates the requirement to take all

available plan loans prior to the hardship– Plans may retain this requirement

– It does NOT eliminate the requirement to obtain other distributions

• Eliminates the facts and circumstances methodology for determining the need (see next slide)

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Is there a Need?• General standard under the proposed regulations

– Hardship may not exceed amount of need adjusted for anticipated taxes and penalties

– Must have obtained all other available distributions under the employer’s plans

– Employee must represent that he or she has insufficient cash or liquid assets to satisfy financial need

• An administrator may rely on this representation unless it has knowledge to the contrary

• This provision is effective 1/1/2020

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Proposed Regulations• Updated regulation to include “primary

beneficiary..” as individual who qualifies for medical, educational or funeral expenses

• Modified the home casualty reason so that it is not limited to federally declared disaster areas (this was an unintended consequence of TCJA 2017)

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New Hardship Event

• Expenses incurred as a result of certain

federally declared disasters (the type the

IRS and Congress have previously given

relief for such as hurricanes, floods,

wildfires, etc.)

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Hardship Events• Medical care*

• Purchase of a principal residence

• Post-secondary education (next 12 months)*

• Prevent eviction or foreclosure from principal residence

• Funeral Expenses*

• Casualty losses

• Disasters

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*Beneficiaries

*Applies to medical, education, funeral

expenses

• Beneficiaries who incur a hardship may

qualify

– Must be primary beneficiary at the time the

hardship occurred

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Clarification Requested

• If a plan wants to stay within the safe

harbor provisions, is the plan required to

permit a hardship distribution for all

events?

– How about for expenses of a beneficiary?

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Proposed Hardship Regulations

• Is there reliance on the regulations?

– IRS Operational Compliance List provides:

• Note: Taxpayers may rely on the proposed

regulations until the date of publication of final

regulations in the Federal Register.

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Implementation• Permissive provisions in the proposed

regulations

– Effective dates (can delay elimination of suspension and new representations until 1/1/2020)

– Requirement to obtain plan loans

– Expansion of sources

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Implementation• Ensure systems are capable of handling

the changes

• What defaults will your firm use?

• Employer communication and elections

• Employee communication

• Plan amendments

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Polling Question #1• An employer is implementing all of the new

hardship provisions as of 7/1/2019

• When must employees be notified of the changes?

– 210 days after the plan is amended

– 210 days after 7/1/2019

– At any time prior to 7/1/2019

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When Must Plans be Amended?

• Individually designed plans must be

amended by the end of the second year

after the issuance of the Required

Amendments List

• There are no rules for 403(b)

arrangements

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Pre-approved Plans• The Treasury Department and the IRS expect that,

if these regulations are finalized as they have been proposed, plan sponsors will need to amend their plans’ hardship distribution provisions.

• The deadline for amending a disqualifying provision is set forth in Rev. Proc. 2016–37

• Optional provisions of the proposed regulations are treated as disqualifying provisions

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Pre-approved Plans• A 401(k) plan sponsor using a pre-approved

plan elects to use all of the new hardship provisions in 2019

• When is an interim amendment required?

– Due date of 2019 tax return

– Due date of 2020 tax return

– We don’t know until final regulations are issued

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Proof of Hardship

• Must have sufficient evidence to satisfy an

IRS audit

• Internal Revenue Manual (IRM) provides

insight

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Records - IRM• Records can be kept in paper or electronic

format

• Retain documentation of the request, review and approval

• Financial information and documentation that substantiates the employee’s immediate and heavy financial need

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Records - IRM

• Documentation to support that the

hardship distribution was properly made

according to the plan and the Code

• Proof of the distribution and related Forms

1099-R

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Who Keeps the Proof?

• Plan administrator retains

• Summary Substantiation Method

– Service provider goes through hoops and

participant retains source documents

– February 23, 2017 IRS memo details the rules

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Polling Question #2

• Does your firm use the summary

substantiation method?

• Yes

• No

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Medical Expenses - IRM• Who incurred the medical expenses (name)?

• What is the relationship to the participant (self, spouse, dependent, or primary beneficiary under the plan)?

• What was the purpose of the medical care (not the actual condition but the general category of expense, for example, diagnosis, treatment, prevention, associated transportation, long-term care)?

• Name and address of the service provider (e.g., doctor)

• Amount of medical expenses not covered by insurance

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Principal Residence - IRM• Will this be the participant’s principal residence?

• Address

• Purchase price

• Types of costs and expenses covered (down-payment, closing costs and/or title fees)

• Name and address of the lender

• Date of the purchase/sale agreement

• Expected date of closing

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Educational Payments - IRM• Who are the educational payments for?

• What is the relationship to the participant (self, spouse, child, dependent, or primary beneficiary under the plan)?

• Name and address of the educational institution

• Category of expenses (e.g., tuition, related fees, room and board)

• Period covered by the educational payments (beginning/end dates of up to 12 months)

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Foreclosure/Eviction - IRM• Is this the participant’s principal residence?

• Address of the residence

• Type of event (foreclosure or eviction)

• Name and address of the party that issued the foreclosure or eviction notice

• Date of the notice of foreclosure or eviction

• Due date of the payment to avoid foreclosure or eviction

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Funeral Expenses - IRM• Name of the deceased

• Relationship to the participant (parent, spouse, child, dependent, or primary beneficiary under the plan)

• Date of death

• Name and address of the service provider (cemetery, funeral home, etc.)

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Repairing Damage - IRM• Is this the participant’s principal residence?

• Address of the residence that sustained damage

• Description of the cause of the casualty loss (e.g., fire, flooding, etc.) including the date of the loss

• Description of the repairs and the date(s) of repair (in process or completed)

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Questions

• Can a plan make a hardship distribution

(assume safe harbor hardship events)?

– Q1: Travel expenses for travel to the funeral

of a participant’s parent?

– Q2: Expenses to repair a crack/leak in the

foundation of the participant’s principal

residence?

Questions

• Q3: Expenses to repair water damage to a

participant’s principal residence from a

flood?

• Q4: Expenses to pay past due mortgage

balance on participant’s principal

residence after receiving a late notice?

Common Questions

• Q5: Pre-payment of expenses for four-

year college tuition of a participant’s child?

• Q6: Credit card payments for expenses

attributable to medical costs?

• Q7: Payments for a student loan for

college tuition?

Hardships and Loans• Cearsi wants a hardship distribution to purchase a

primary residence ($25,000 for a down payment)

• She could borrow the $25,000 by obtaining a commercial loan

• The bank will not give her a first mortgage if she borrows the $25,000 down payment

• Can the plan make the $25,000 hardship distribution?

Counterproductive Actions(D) Employee need not take counterproductive actions. For purposes of [the necessity regulations], a need cannot reasonably be relieved by one of the actions described in paragraph (d)(3)(iv)(C) [such as taking a loan] if the effect would be to increase the amount of the need. For example, the need for funds to purchase a principal residence cannot reasonably be relieved by a plan loan if the loan would disqualify the employee from obtaining other necessary financing.

Hardships are a Pain in the…

• Can I amend a plan to eliminate hardship

distributions?

• Yes, this is a “permissible” cutback of

benefits

– IRC §401(a)(4) issues if you do not eliminate

it for all participants

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Excise Tax

• The 10% early distribution excise tax

applies to amounts includible in income

• There are numerous exceptions

– Hardship distributions or taxable loan defaults

are not automatically exempt

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Excise Tax Exceptions

• Distributions after age 59 ½

• Distributions due to death or disability

• Payments made in a series of substantially

equal periodic payments

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Excise Tax Exceptions

• Distributions made after separation from

service after age 55

– Must be bona fide separation from service

• Corrective distributions and QDROs

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In-Plan Roth Rollovers

• Distributions of amounts that were

converted to Roth via an in-plan Roth

rollover may be subject to a recapture tax

– Prevents avoidance of the excise tax

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Recapture Tax - Example• A participant is under 59 ½ and wants a

hardship of pre-tax amounts

– 10% excise tax would apply

• The participant elects an in-plan Roth rollover

– This is not an actual distribution so no 10% tax

• Participant then receives the hardship distribution and basis is not taxable

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Recapture Tax - Example

• The participant then receives the hardship

distribution

– Basis is not taxable and normally and

normally not subject to 10% excise tax

• Recapture tax prevents this

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Recapture Tax• The excise tax applies if an IPPR is

withdrawn prior to 5 years

– Calendar year determination that begins on CY of IPPR

• Each IPPR has a separate 5-year period

• If multiple IPPRs then earliest is withdrawn first

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Polling Question #3

• A participant obtains a hardship withdrawal

• How much is the plan required to withhold

for federal income taxes?

– 0%

– 10%

– 20%

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Income Tax Withholding• Answer: 10%

• 20% withholding is only required for an eligible rollover distribution

– A hardship distribution is not an eligible rollover distribution

• The participant can elect different withholding using Form w4-p

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What is a DRO?• A Domestic Relations Order (DRO) means

any judgment, decree, or order which—

– relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child, or other dependent of a participant, and

– is made pursuant to a State domestic relations law

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When DRO Received

• Notify affected parties and provide QDRO

procedures

• Segregate the amount subject to the order

• Suspend distributions and loans of the

segregated amount

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Review

• Make a determination on the DRO within a

reasonable period of time

• If QDRO then

– Notify affected parties

– Make payments in accordance with QDRO,

subject to plan terms

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Sham Divorces

• The plan should not question DROs

• Plan’s only concern is whether a DRO is a

QDRO

– Brown vs. Continental Air Lines No. 10-20015

(5th Cir. July 18, 2011)

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Timing of Payment

• Most plans permit a distribution to an

alternate payee prior to the time a

participant can receive a distribution

• Regardless of plan terms, QDRO can

require payments at the “earliest

retirement age”

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Earliest Retirement Age

• Earlier of:

– Date participant entitled to distribution, or

– Later of:

• Participant’s attainment of age 50, or

• Earliest date participant could receive benefits

after separation from service

Ordering

• Pro-rata distribution if the account includes

Roth and pre-tax accounts

• Existing plan loan remains with participant

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What if no DRO?

• The administrator may suspend distributions

and loans if it is on notice (verbal or written)

regarding a pending domestic relations action

(e.g., a divorce) and has a reasonable belief

the Participant's account may become

subject to a QDRO

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What if no DRO?• The administrator will notify the participant

of the suspension

• To lift the suspension, the participant must provide ?? (e.g., written confirmation that a court will not issue a QDRO)

• Suspension lifted after ?? days

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Polling Question #4

• Would you suspend loans and

distributions if you were aware of a

potential divorce?

– Yes

– No

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PARTICIPANT

LOANS

Default vs. Offset• Default is when loan is deemed taxable

– No later than quarter after the quarter in which the last payment was due

• Offset is when the loan note offsets the participant’s account

– Can only happen if distribution could have been made under the law

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Example

• Participant is age 30 and defaults on a loan

made out of elective deferral account

• Loan cannot be offset until earliest date plan

could make a distribution under the law

– Age 59 ½ if not termination of employment

– Doesn’t matter whether plan actually allows in-

service distributions60

Why do We Care?

• The loan remains in existence until there is

an offset

– For purposes of Form 5500

– For purposes of determining the maximum

amount of another loan

• Interest continues to accrue for this purpose

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Can a Loan be Rolled Over?

• Yes provided:

– Distributing plan allows an in-kind distribution

(the note)

– Receiving plan allows the rollover

• Loans may not be rolled to IRAs

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Can a Loan be Rolled Over?

• What if the receiving plan does not permit

loans?

• What if the loan is due and payable on

termination of employment?

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Hardship

• Can a note be extinguished as part of a

hardship distribution?

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Answers to Common

Questions Regarding

Distributions