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The Bipartisan Budget Act of 2018 (the “Budget Act”), which was adopted February 9, 2018, together with the Tax Cuts and Jobs Act (the “Tax Act”), which was adopted on December 22, 2017, and the Disaster Tax Relief and Airport and Airway Extension Act of 2017 (the “Hurricane Relief Act”), which was adopted on September 29, 2017, introduced several changes to the qualified retirement plan loan and distribution rules. These changes, discussed below, may impact retirement plan operations and create new plan design opportunities. Plan sponsors should consult counsel and consider whether it is necessary or desirable to amend their plans in light of the new rules.
Increased Opportunity for Hardship Distributions.
The Budget Act relaxed certain restrictions applicable to hardship distributions under the Internal Revenue Code of 1986, as amended (“Code”). Under current law, hardship distributions are subject to the following limitations: (i) hardship distributions are available only after a participant has taken all available plan loans; (ii) they may only be taken from employee salary deferrals (excluding any earnings that accumulate); and (iii) participants may not make salary deferrals to qualified retirement plans and certain other plans for six months following the distribution.
Effective January 1, 2019, for calendar year plans, the Budget Act removes the requirement that a participant take all available plan loans before being eligible for hardship distributions and also removes the six-month prohibition on salary deferrals following receipt of a hardship distribution. Additionally, the Budget Act makes three additional sources of assets eligible for hardship distribution: (1) earnings on salary deferral contributions; (2) qualified non-elective contributions (including earnings thereon); and (3) qualified matching contributions (including earnings thereon).
Action Item – Plan sponsors who wish to incorporate the more lenient hardship distribution rules under the Budget Act will likely need to adopt plan amendments, taking effect no earlier than January 1, 2019, and communicate any such changes to participants. If a plan incorporates the hardship distribution rules by reference, plan sponsors should align plan operations consistent with these changes when the rules go into effect on January 1, 2019.
New Limitation on “Safe Harbor” Hardship Distributions.
A notable, if perhaps unintentional, change under the Tax Act may limit the opportunity for participants to utilize hardship distributions if the plan uses the hardship distribution safe harbor design (which is the case for most 401(k) plans). Under the safe harbor, participants who experience damage to their primary residence that qualifies for a casualty loss deduction under Code Section 165 are deemed to have an “immediate and heavy financial need” for purposes of the hardship distribution rules. The Tax Act limits losses eligible for the casualty loss deductions under Code Section 165 to losses caused by federally-declared disasters for periods after December 31, 2017 and before January 1, 2026. Previously the Code Section 165 deduction was permitted for losses caused by extreme weather events more generally. Because the Treasury Regulations describing the availability of a safe harbor hardship distribution for expenses incurred for the repair of damage to an employee’s principal residence require that such amounts qualify for the Code Section 165 casualty loss deduction, plans utilizing this safe harbor hardship distribution provision will be impacted by this new limitation operationally.
Action Item – Plan sponsors should review their plan rules to determine whether future casualty loss distributions need to be limited. Plan sponsors currently permitting distributions based on the casualty loss safe harbor hardship distribution who do not wish to limit the availability of hardship distributions as a result of casualty losses attributable to non-federally-declared disasters could amend their plans to use a “facts and circumstances” test for determining when a participant has experienced an “immediate and heavy financial need.”
This action would, however, cause the plan to use a non-safe harbor hardship distribution design, which will increase the burden of administering hardship distributions and the risk of non-compliance with the plan qualification rules. In any event, sponsors of plans with a safe harbor hardship distribution design should take note of this change and align their operations accordingly.
Tax Relief for Victims of Natural Disasters.
Under the Tax Act, the Budget Act, and the Hurricane Relief Act, Congress extended tax relief to individuals impacted by the recent spate of natural disasters with respect to in-service retirement plan distributions and plan loans. There are some differences between the relief offered under each of the acts, and plan sponsors should be mindful of the various limitations, as well as the deadlines for amending plans to incorporate the applicable disaster distribution rules.
Relief for 2017 Hurricane Victims. The Hurricane Relief Act provided tax relief to individuals impacted by Hurricanes Harvey, Maria and Irma (the “2017 Hurricanes”), creating special in-service distributions called “qualified hurricane distributions”. Qualified hurricane distributions, which may not exceed $100,000, are exempt from the 10% tax on early withdrawals and mandatory 20% withholding does not apply. Additionally, the amount distributed may be repaid to the plan or rolled over (i.e., repaid to another retirement plan, including an IRA) within three years after the distribution is received to avoid inclusion of the amount in taxable income. If the distributee does not wish to repay or rollover the amount, the Hurricane Relief Act permits the amount of the distribution to be ratably included in taxable income over three years. In addition to distributions, special plan loans are available to victims of the 2017 Hurricanes.
Under the Hurricane Relief Act, the plan loan limit is increased from $50,000 to $100,000 (and the 50% limit does not apply), and repayments are not required to begin until one year after the loan is initiated. Additionally, the maximum repayment term for these loans was correspondingly extended by one year, so the delay in commencement of repayments does not shorten the maximum repayment schedule. Qualified hurricane distributions and plan loans are available between the date of the respective 2017 Hurricane and January 1, 2019.
Action Item – Plans that permit these special in-service distributions or plan loans to victims of the 2017 Hurricanes must amend their plans to include the enabling language no later than December 31, 2019 (for calendar year plans). If the plan is maintained pursuant to a prototype plan document, the plan sponsor should contact the document provider to determine if an amendment has been prepared, or will be prepared, regarding this issue.
Relief for California Wildfire Victims. Under the Budget Act, Congress extended relief to victims of California wildfires occurring between January 1, 2017 and January 18, 2018 (the “California Wildfires”). In-service distributions and plan loans made between October 8, 2017 and January 1, 2019 are eligible for the same tax relief provided to victims of the 2017 Hurricanes, subject to the same limits described above.
Further, the Budget Act provides an additional benefit to victims of California Wildfires. It allows for re-contribution of distributions received between March 31, 2017 and January 15, 2018 that were originally made to purchase or construct a home in the California Wildfire disaster area but were cancelled because of a California Wildfire. If the amount distributed is re-contributed or rolled over no earlier than October 8, 2017, and no later than June 30, 2018, it may be treated as a non-taxable distribution.
Action Item – Plans that permit these special in-service distributions, plan loans or re-contribution of retirement plan distributions for victims of the California Wildfires must amend their plans to include the enabling language no later than December 31, 2019 (for calendar year plans). If the plan is maintained pursuant to a prototype plan document, the plan sponsor should contact the document provider to determine if an amendment has been prepared, or will be prepared, regarding this issue.
Qualified 2016 Disaster Distributions. The Tax Act provided the same relief afforded to 2017 Hurricane victims and California Wildfire victims for special in-service distributions – but not plan loans – from qualified plans taken between January 1, 2016 and January 1, 2018 by an individual affected by a federally declared disaster in 2016 (“2016 Disasters”).
Action Item – Plans that permitted these special in-service distributions to victims of 2016 Disasters must amend their plans to include the enabling language no later than December 31, 2018 (for calendar year plans). If the plan is maintained pursuant to a prototype plan document, the plan sponsor should contact the document provider to determine if an amendment has been prepared, or will be prepared, regarding this issue.
More Time to Roll Over Outstanding Plan Loan Balance.
As discussed in a recent Locke Lord QuickStudy, the Tax Act extends the time by which an employee whose plan terminates or who separates from service while a plan loan is outstanding can roll over the unpaid loan balance (i.e., repay to another retirement plan, including an IRA) to avoid that amount being treated as a taxable distribution. Prior to the Tax Act, upon taking a distribution of his or her account balance, an employee had sixty days to roll over the unpaid portion of an outstanding loan to avoid treatment of the amount as a taxable distribution. Starting in 2018, the employee will have until the due date for filing the employee’s tax return for the year in which the account balance distribution (and offset) occurs to roll over an outstanding loan balance.
Action Item – Plan sponsors should review their plan loan default and “offset” procedures with their plan’s third-party administrator to ensure the new rule under the Tax Act is being implemented appropriately.
Relief for Improper Federal Tax Levy.
Effective January 1, 2018, a wrongful federal tax levy on retirement plan assets may be re-contributed or rolled over to another retirement plan or IRA by the tax filing deadline (excluding extensions) for the year of the refund of the tax levied to avoid treatment of the amount as a taxable distribution. The IRS is required to notify any affected individual of his or her right to re-contribute or roll over the wrongfully levied assets upon issuance of the refund.