The Internal Revenue Service (IRS) has announced that 401(k)s and similar employer-sponsored retirement plans, including 403(b) and 457(b) plans, can make loans and hardship distributions to victims of Hurricane Matthew and members of their families. As a result, participants of these plans may be eligible to take advantage of certain streamlined loan procedures and relaxed hardship distribution rules.
Relief is available to employees and certain members of their families who live or work in disaster area localities affected by Hurricane Matthew and designated for individual assistance by the Federal Emergency Management Agency (FEMA). As of today, affected disaster areas include Brevard, Flagler, Indian River, Putnam, St. Johns and Volusia counties in Florida; Bryan, Bulloch, Chatham, Effingham, Glynn, McIntosh, and Wayne counties in Georgia; Beaufort, Bertie, Bladen, Columbus, Craven, Cumberland, Dare, Duplin, Edgecombe, Gates, Greene, Harnett, Hoke, Hyde, Johnston, Jones, Lenoir, Martin, Nash, Pender, Pitt, Robeson, Sampson, Tyrrell, Washington, Wayne and Wilson counties in North Carolina; Allendale, Bamberg, Barnwell, Beaufort, Calhoun, Clarendon, Colleton, Darlington, Dillon, Dorchester, Florence, Georgetown, Hampton, Horry, Jasper, Lee, Marion, Marlboro, Orangeburg, Sumter and Williamsburg counties in South Carolina. For a complete, up to date list of eligible counties, visit https://www.fema.gov/disasters.
To qualify for this relief, hardship withdrawals must be made by March 15, 2017.
A retirement plan may, but is not required to, provide for hardship withdrawals. If a plan does provide for hardship withdrawals, the specific criteria used to make the determination of a hardship must typically be outlined in the plan. With the more relaxed relief, plans will be allowed to make loans or hardship distributions before the plan is formally amended to provide hurricane-related relief. In addition, under IRS relief rules, the plan can ignore the reasons that normally apply to hardship distributions so that funds can be used, for example, for food and shelter even if not outlined in the plan. If a plan requires documentation before a distribution is made, the plan can relax this requirement.
Under IRS rules, the hardship must be related to an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need (you can’t take out more than you need). Financial need includes those expenses that affect the employee’s spouse and dependent. Examples may include medical or funeral expenses.
Under the relaxed rules, a retirement plan can allow a person who lives outside the disaster area to take out a hardship distribution (or retirement plan loan – see below) and use it to assist a son, daughter, parent, grandparent or other dependent who lived or worked in the disaster area.
Typically, if you take a hardship distribution, you are banned from contributing back to the plan for six months. Under the current relief offered by IRS, the six-month ban on 401(k) and 403(b) contributions that normally affects employees who take hardship distributions will not apply.
Note that the “regular” rules still apply to taxation. Hardship distributions are generally taxable (unless the distributions are from a designated Roth plan). Also, an additional tax on early distributions of elective contributions may apply.
Be sure not to take out more than you need. Not only is this banned under IRS rules, as noted above, but since hardship distributions are not repaid, those distributions reduce your overall retirement balance. Additionally, a hardship distribution cannot be rolled over into an IRA or another qualified plan.
(For more on taxpayer relief related to filing and paying taxes, check out this post.)
There is no such thing as a “hardship distribution” from an IRA. That’s because there is generally no limit on withdrawals from your IRA. However, there are tax consequences for withdrawals which may include an additional tax on early distributions. However, some distributions from an IRA – like for use in financing a first-time home purchase – are exempt from the additional tax on early distributions. Check with your tax professional if you’re not sure.
There is also no such thing as a loan from an IRA. However, your qualified plan, like a 401(k), may, but is not required, to offer you a loan against your balance. If a plan allows loans, plan limits may apply: IRS rules also limit those amounts. Unlike hardship distributions, loans are not dependent upon need so, depending on what the plan requires, you can use it to finance your trip to Aruba (though I’m not saying that’s a good idea).
Ordinarily, retirement plan loan proceeds are tax-free if they are repaid over a period of five years or less. If you don’t pay your loan back on time, it’s treated as a distribution from the plan and taxed accordingly.
If all of this is a bit confusing, check with your Human Resources (HR) person or investment advisor for more information. Qualified plans must be in writing so the specifics of the plan offered by your employer are easily accessible in black and white (and/or online).
