B—Hardship Distributions
A retirement plan may, but is not required to, provide for hardship distributions. Thus many, but not all, 401(k), 403(b), and 457(b) plans have provisions allowing hardship distributions.
The 401(k) plan documents or 403(b) plan documents must have provisions specifically allowing
for hardship distributions and must specify nondiscriminatory and objective standards as
well as the criteria used to make a determination. A 457(b) plan must contain specific language
defining what constitutes a distribution on account of an "unforeseeable emergency."
For a distribution from a 401(k) plan to be on account of hardship, the Treasury Regulations
provide that it must be made on account of "an immediate and heavy financial need of the
employee" and the amount "must be necessary to satisfy the financial need." Generally, the need must be that of the employee, spouse, or dependent.
Facts and circumstances determine if a need is "immediate and heavy" and not all needs must
be allowed for in the plan documents. In fact, it isn't uncommon for a plan document to only allow for hardship distributions associated with medical expenses and funeral expenses. The following expenses are delineated in the Treasury Regulations as being potentially immediate and heavy:
(1) medical expenses incurred by the employee, spouse, or dependents;
(2) costs relating to the purchase of the employee's principal residence;
(3) tuition and related educational fees and expenses of the employee, spouse, or dependents;
(4) payments necessary to prevent eviction or foreclosure on the employee's principal residence;
(5) burial or funeral expenses for the employee's parent, spouse, children or other dependents;
and
(6) certain expenses for the repair of damage to the employee's principal residence that would
qualify for the casualty deduction under IRC Section 165.
The amount of the distribution can also include an amount necessary to pay federal, state, and local taxes anticipated from the distribution.
A distribution is NOT considered necessary to satisfy an immediate and heavy financial need of an employee if the employee has other resources available to satisfy the need, including assets of the spouse and minor children. The regulations provide an example of an employee with a vacation home who would be expected to first liquidate that property, if possible, before receiving hardship distributions.
When making a hardship distribution, the employer may reasonably rely on the employee's written representation that the need cannot be relieved through reimbursement or compensation by insurance, by reasonable liquidation of the employee's assets, by cessation of future elective contributions to the plan, by other distributions or nontaxable loans from another plan, or by a commercial loan. Hardship distributions are generally limited to the employee's total elective contributions as of the date of distribution reduced by the amount of previous hardship distributions.
In recent years, it seems that natural disasters have brought unprecedented loss of life and property. 2017 was especially notable for hurricanes Harvey and Irma that brought mass destruction to large portions of Texas and Florida.
As a result of what appeared to be an increase in similar natural disasters, The Taxpayer Certainty and Disaster Act of 2019 amended IRC section 7508A by adding a new mandatory 60-day postponement period for certain taxpayer acts following a federally declared disaster. Final regulations were adopted for these changes in June of 2021.