(b)lines Ask the Experts – Amounts Allowed for 403(b) Hardships Under Budget Bill

“However, we read an article that indicates that the newly passed budget act may have changed all that, so that contributions and earnings may be distributed. Is this true?”

Stacey Bradford, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

This is an interesting question to answer at this point, as all we have to go on is the recently enacted legislation, known as the Bipartisan Budget Act of 2018. The relevant section of the legislation adds a new Section 401(k)(14) to the Code, as follows (underlined text reflects the Experts’ emphasis):

‘‘(14) SPECIAL RULES RELATING TO HARDSHIP WITHDRAWALS.—For purposes of paragraph (2)(B)(i)(IV)— ‘‘(A) AMOUNTS WHICH MAY BE WITHDRAWN.—The following amounts may be distributed upon hardship of the employee: ‘‘(i) Contributions to a profit-sharing or stock bonus plan to which section 402(e)(3) applies. ‘‘(ii) Qualified nonelective contributions (as defined in subsection (m)(4)(C)). ‘‘(iii) Qualified matching contributions described in paragraph (3)(D)(ii)(I). ‘‘(iv) Earnings on any contributions described in clause (i), (ii), or (iii).

Since Code Section 402(e)(3) is referenced, we must now turn to that section of the Code, as follows (again, underlined text reflects the Experts’ emphasis)

402(e)(3) Cash or deferred arrangements

For purposes of this title, contributions made by an employer on behalf of an employee to a trust which is a part of a qualified cash or deferred arrangement (as defined in section 401(k)(2)) or which is part of a salary reduction agreement under section 403(b) shall not be treated as distributed or made available to the employee nor as contributions made to the trust by the employee merely because the arrangement includes provisions under which the employee has an election whether the contribution will be made to the trust or received by the employee in cash.

Now, admittedly, the reference to 402(e)(3) here is not as helpful as it could be, as the specific language refers to a profit-sharing or stock bonus plan to which 402(e)(3) applies, and profit-sharing and stock bonus plans  generally consist of employer contributions, and not elective deferrals. However, the specific reference to 402(e)(3) implies that earnings on elective deferrals (including earnings on 403(b) elective deferrals) would be included in the definition of hardship, since it is specifically those contributions that are mentioned in 402(e)(3).

Thus, it would appear that hardship distributions will include earnings on elective deferrals, even for 403(b) plans. However, a careful reading of the final 403(b) regulations may throw a bit of a monkey wrench into this process, as follows (again, the underlined text reflects the Experts’ emphasis)::

• 1.403(b)-6 Timing of distributions and benefits.

(2) Hardship rules. A hardship distribution under this paragraph (d) has the same meaning as a distribution on account of hardship under §1.401(k)-1(d)(3) and is subject to the rules and restrictions set forth in §1.401(k)-1(d)(3) (including limiting the amount of a distribution in the case of hardship to the amount necessary to satisfy the hardship). In addition, a hardship distribution is limited to the aggregate dollar amount of the participant’s section 403(b) elective deferrals under the contract (and may not include any income thereon), reduced by the aggregate dollar amount of the distributions previously made to the participant from the contract.

Thus, not only do the 403(b) regulations reference the 401(k) regulations in this regard (which, unlike the Code, were NOT modified by the Budget Act), there is a specific exclusion for earnings on elective deferrals! Now, it makes little sense to permit earnings on elective deferrals in 401(k) plans to be distributed for hardship, but not earnings on elective deferrals on 403(b) plans, but certainly the current regulations as they are written can lead to that conclusion.

Fortunately the change is not effective until 1/1/2019, and, presumably the Internal Revenue Service (IRS) will have the opportunity to sort this out by providing revised 401(k) regulations (as they have been directed to do in the budget act) and, perhaps, revised 403(b) regulations as well, to address the potential issues described above.

Until then, stay tuned!

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.