Distributing Plan Benefits
Benefits in a plan are dependent on a participant’s account balance at the time of distribution.
When participants are eligible to receive a distribution, they typically can elect to:
- Take a lump sum distribution of their account,
- Roll over their account to an IRA or another employer’s retirement plan, or
- Purchase an annuity.
When such a transaction occurs, the distribution is subject to a mandatory withholding of 20% unless the money is reinvested within 60 days. The exciting news is that traditional and Roth (after tax money) IRA's are now accepted as qualified plans eligible for rollover. Please refer to the Summary Plan Description as to the availability of distributions in the plan.
Here is a condensed list of transactions that are not eligible for rollovers:
- Required minimum distributions under 401(a) (9), even if a beneficiary is named
- Hardship Distributions
- Any cash distributions which have an annual total amount less then $200
- Distributions of premiums for accident or health insurance under Regulation 1,402 (a)-1(e).
- Prohibited allocation of securities in an S corporation that are treated as distributions
- Code Section 414(w) Permissible withdrawal
- QDRO payment to an alternate payee who is not the employee's spouse of former spouse (i.e. a child)
- Cost of current life insurance protection
- Deemed Distribution of a participant loan
- Corrective Distributions plus earnings
- Distribution of only employer securities or only a participant loan distributed to the participant in kind is eligible for rollover, but no subject to withholding
- Funds from a participant who has already retired and is receiving an annuity distribution
This list covers the basics; however, a few other transactions also fail to qualify for rollover eligibility under Code Section 401(a)(31).
Unlike hardship withdrawals, all qualified plans must make provisions to allow participants to rollover their eligible distributions. The only choice the employer really has is to decide whether or not they would like to accept a rollover contribution from another qualified plan.
Although not required, a retirement plan may allow participants to receive hardship distributions. A distribution from a participant’s elective deferral account can only be made if the distribution is both:
- Due to an immediate and heavy financial need.
- Limited to the amount necessary to satisfy that financial need.
Immediate and heavy financial need
The employer determines a participant has an immediate and heavy financial need based on the plan terms and all relevant facts and circumstances.
- Consumer purchases (such as a boat or television) are generally not considered an immediate and heavy financial need.
- A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee.
A distribution is automatically considered to be necessary to satisfy an immediate and heavy financial need if all of the following requirements are met:
- The distribution isn't greater than the amount of the immediate and heavy financial need, including the amounts necessary to pay any taxes resulting from the distribution.
- The employee has obtained all other currently available distributions (including distribution of ESOP dividends under section 404(k), but not hardship distributions) and nontaxable (at the time of the loan) plan loans, including all other plans maintained by the employer.
- The employee isn't allowed to make elective deferrals to the plan for at least six months after the hardship distribution.
Safe Harbor Distributions
- Effective Feb. 23, 2017, 401(k) plans may elect to use the "Summary substantiation method" for the six types of hardship distributions below.
- Effective March 7, 2017, 403(b) plans may elect to use the "Summary substantiation method" for the six types of hardship distributions below.
Under a “safe harbor” in IRS regulations, an employee is automatically considered to have an immediate and heavy financial need if the distribution is for any of these:
- Medical care expenses for the employee, the employee’s spouse, dependents or beneficiary.
- Costs directly related to the purchase of an employee’s principal residence (excluding mortgage payments).
- Tuition, related educational fees and room and board expenses for the next 12 months of postsecondary education for the employee or the employee’s spouse, children, dependents or beneficiary.
- Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence.
- Funeral expenses for the employee, the employee’s spouse, children, dependents, or beneficiary.
- Certain expenses to repair damage to the employee’s principal residence.
Limited to the amount necessary
The amount of a hardship distribution must be limited to the amount necessary to satisfy the need. This rule is satisfied if:
- The distribution is limited to the amount needed to cover the immediate and heavy financial need, and
- The employee couldn't reasonably obtain the funds from another source.
Unless the employer has actual knowledge to the contrary, the employer may rely on the employee’s written statement that their need can’t be relieved from other available resources, including:
- Insurance or other reimbursement.
- Liquidation of the employee’s assets.
- The employee’s pay, by discontinuing elective deferrals and after-tax employee contributions.
- Plan loans or reasonable commercial loans.
An employee doesn’t have to use alternative resources if doing so would increase the amount of the need. For example, an employee requesting a hardship to purchase a principal residence doesn’t have to obtain a plan loan if the loan would disqualify the employee from obtaining other necessary financing.
Account balances eligible for hardship distributions
In a 401(k) plan, hardship distributions can generally only be made from accumulated:
- elective deferrals (not from earnings on elective deferrals)
- employer nonelective contributions (sometimes referred to as “profit-sharing contributions”) and
- regular matching contributions.
A plan may, but isn't required to, apply the same conditions to hardship distributions of employer nonelective and regular matching contributions as it applies to hardship distributions of elective deferrals. Some 401(k) plans may allow hardship distributions of certain kinds of contributions made to the plan before 1989.
Tax treatment of hardship distributions
Hardship distributions are subject to income taxes (unless they consist of Roth contributions). They may also be subject to a 10% additional tax on early distributions. Employees who take a hardship distribution can't:
- repay it to the plan, or
- roll it over to another plan or an IRA.
Changes coming for 2019
The Bipartisan Budget Act of 2018 enacted three changes to these rules, specifically:
- repealing the previously-required 6-month suspension of elective deferrals after a participant received a hardship distribution
- permitting amounts previously contributed as qualified non-elective or qualified matching contributions (QNECs/QMACs) to be available as a hardship distribution.
- removing the requirement to take available plan loans prior to requesting a hardship.
- Regulations are also proposed which would further:
- revise the applicable standards governing when a distribution can be made on account of hardship
- permit hardship distributions to participants seeking to repair a primary residence, even if that repair would not otherwise qualify for a casualty loss deduction
- apply most of these rules to participants in 403(b) arrangements
A retirement plan may (but is not required to) allow participants to receive hardship distributions. Please contact the Employer or refer to the Summary Plan Description.
Age restrictions, years of participation, or vesting requirements may apply.
Termination or Retirement Withdrawal
Each plan is designed with different plan features, please refer to the Summary Plan Description as to the timing of plan distributions. Some plans allow distributions to occur immediately, after annual administration, or as late as retirement age.