How Does the New Distribution Provision for Terminal Illness Work?

Q: We know that, thanks to the SECURE 2.0 Act of 2022, the hardship distribution rules for our 403(b) plan will now be the same as the rules for 401(k) plans. But will these rules include the new distribution provision for terminal illness as a category of hardship? Or will a terminally ill participant have to terminate employment or prove a different category of hardship to receive a distribution from the plan?

Kimberly Boberg, Taylor Costanzo, Kelly Geloneck and David Levine, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:

A: You are correct: SECURE 2.0 did generally sync up 401(k) and 403(b) hardship distributions. However, those rules are separate from the new terminal illness distribution.

Section 326 of the SECURE 2.0 Act merely provides a new exception to the 10% additional tax under Section 72(t) of the Internal Revenue Code, which is applicable to both 401(k) and 403(b) plans, for distributions made to a terminally ill individual. However, Section 326 does not create a category of deemed hardship or another distribution right under a plan.

Therefore, a participant must be otherwise eligible to take a distribution under the plan to receive the benefit of a penalty-free withdrawal on account of terminal illness. For example, if a terminally ill participant qualifies for another hardship category under the plan (e.g., on account of medical care expenses), the participant may avoid the 10% tax on such early withdrawal, if otherwise applicable.

While plans may choose whether to specifically support the exception from the tax for distributions on account of terminal illness under their plan, an eligible participant may claim an exception to the 10% tax when filing their taxes, whether or not offered by the plan. If this exception to the early withdrawal penalty is offered by the plan (which would require a plan amendment), it is important to note that the plan cannot rely solely on a self-certification that the participant is terminally ill. The IRS recently issued Notice 2024-2 to provide additional information on these distributions, including the required supporting documentation.

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.

Do YOU have a question for the Experts? If so, we would love to hear from you! Simply forward your question to Amy.Resnick@issgovernance.com with Subject: Ask the Experts, and the Experts will do their best to answer your question in a future column.