The IRS has issued relief to make it is easier for participants to take hardship distributions from 401(k) plans. The IRS has relaxed certain documentation requirements, but has not totally eliminated the need for documentation. Irma relief is only available through January 31, 2018.
Things that participants need to know:
- In order to take a hardship distribution, your employer’s plan must allow for hardship distribution. Plans are not required to permit hardship distributions. You can find out if your plan allows hardship distributions by talking to the plan administrator or checking your plan’s Summary Plan Description. If you want a hardship distribution and your 401(k) plan does not allow for hardship distributions, ask your employer to amend the plan to allow hardship distributions. Defined benefit plans and cash balance plans cannot provide hardship distributions.
- If you are eligible for a 401(k) plan loan, you may be required to take a loan before taking a hardship distribution. Sometimes this requirement is waived if you certify that taking a loan would increase your financial hardship. But, keep in mind, a 401(k) plan loan is not taxable as long as you repay it on time. So, it may be a better strategy to first take available loans and then take a hardship distribution.
- Your entire 401(k) account may not be available for withdrawal under the law or terms of your plan. For example, sometimes the 401(k) plan provides that only employee contributions are eligible for hardship withdrawals, but not any employer contributions.
- Hardship distributions are taxable distributions. Your hardship distribution will be subject to income tax and you will receive a 1099-R reporting the taxable amount next year. If you withdraw Roth money, it is not subject to double taxation. But, pre-tax money such as your pre-tax 401(k) contributions will be taxed. If your plan allows hardship withdrawals from employer contributions, those amounts are taxable. Usually 10% of the tax amount is withheld unless you request another amount to be withheld for taxes. Your actual taxes due when you file your final return may be higher or lower.
- Participants under the age of 59 1/2 will generally be subject to the 10% additional withdrawal tax. The 10% withdrawal tax does not apply to Roth money.
- Your 401(k) plan is not required to apply the IRS-issued Irma relief. If your employer is not applying the relief and you want them to, ask them to apply the relief. If they are unwilling to do so, look at the typical hardship distribution rules. We are early in the process, but well in excess of 90% of the hardship distributions that we are seeing related to Hurricane Irma would qualify as a typical hardship distribution. For example, two typical hardship distribution reasons are to repair your home due to storms (called a casualty loss) or to prevent eviction or foreclosure from your primary residence.
- If your employer is applying the Irma hardship distribution reasons, you may be able to apply for a hardship distribution for a wide variety of reasons related to Irma: temporary shelter, flooded cars, etc.
- Employers are implementing the Irma hardship distribution relief in different ways. At a minimum, you will probably be asked to sign a certification stating that you have a financial need and that your need meets certain criteria. You may be asked to provide documentation to support the amount you are requesting. For example, if your home was flooded and you need to clean it out and repair it, you may be asked for bids or estimates to repair your home. Because different employers and 401(k) providers are implementing the guidance in different ways, it is probably fastest to have documentation ready if you can reasonably do so. If you cannot reasonably provide documentation, talk to your employer or 401(k) provider about signing a certification or providing alternate documentation.
- Usually there is a requirement for your employer to stop your 401(k) contributions for 6 months following a hardship distribution. However, your employer may choose not to enforce this rule with Irma hardship distributions.
- Your plan or 401(k) provider, may charge a fee for the hardship distribution. There are legitimate costs and work associated with processing these distributions. But, inquire about the fee, particularly if you have other ways to get the necessary funds so that you can make an informed decision. The fee is generally unrelated to the size of the distribution. So, for a hardship distribution of $1,000 or $2,000, the fee may seem disproportionately large.
- If possible have the proceeds ACHed or wired to you instead of a paper check. In general, participants are surprised by how long it takes a check to travel across country. And, this is truer when the mail is slowed down due to storms.