Hardship Withdrawal Safe Harbor Covers Tuition, But Not Loan Repayments

A timely new Insights publication from the law firm of Drinker, Biddle and Reath looks back at an Internal Revenue Service (IRS) letter sent earlier this year to Representative Scott Perry, R-Pennsylvania, in response to his inquiry about whether individual taxpayers can use a qualified 401(k) plan hardship withdrawal for the purpose of paying down student loan debt.

Reviewing the IRS response—formally published as Information Letter 2018-1—Karen Gelula, counsel, and Betsy Olson, associate, point out how the IRS emphasized that a hardship distribution must, among other things, be necessary to satisfy “an immediate and heavy financial need.”

As Gelula and Olson note, the letter does not directly address the plan provisions applicable to the specific constituent about whom Perry pinged the IRS, but instead notes that under the safe harbor standards for hardship distributions in the Internal Revenue Code Section 401(k) regulations, “education expenses” can in some cases be deemed a sufficiently immediate and heavy financial need, but only if they are for the “payment of tuition, related educational fees, and room and board expenses, for up to the next 12 months of post-secondary education.”

“The IRS confirmed in the letter that because a safe harbor hardship distribution may be made only for the prospective payment of education expenses, it cannot be made for the repayment of student loans,” Gelula and Olson write. “The IRS suggested that as an alternative to taking a hardship distribution, the participant may be able to get a loan from the plan.”

The attorneys further observe that 401(k) plans which permit non-safe harbor hardship distributions as described in the Internal Revenue Code Section 401(k) regulations could theoretically approve a participant’s hardship distribution request for the repayment of student loans, “provided that the loan repayment constitutes an immediate and heavy financial need based on all the relevant facts and circumstances.”

“Among other things, this includes the participant’s representation that the need cannot be relieved from other reasonably available resources such as insurance reimbursement, liquidation of the participant’s assets, cessation of plan contributions, other currently available distributions such as employee stock ownership plan dividends and non-taxable (at the time of the loan) plan loans, or borrowing from commercial sources,” the attorneys explain.

They also remind plan fiduciaries that the hardship distribution provisions will be changing in 2019, including the removal of the requirement in the safe harbor hardship distribution standards that a participant “take all available plan loans to demonstrate financial necessity.”

“In addition, the Treasury Secretary has been directed to remove from the safe harbor hardship distribution standards the requirement that the participant’s deferral contributions to all plans maintained by the employer must be suspended for six months following the withdrawal,” the attorneys point out.

The full IRS Information Letter 2018-01 is available here.