Seyfarth Synopsis: The Federal Emergency Management Agency (FEMA) has declared several disaster areas around the United States as a result of the spread of the coronavirus (COVID-19). As of publication, the entire states of California, New York, Washington, Iowa and Louisiana are declared disaster areas. Pursuant to final regulations issued in 2019, a federal disaster declaration has become one of the safe harbor reasons that qualifies a 401(k) or 403(b) plan participant for a hardship distribution, so it appears that plan participants may now be able to take a hardship withdrawal if they are laid off, put on an unpaid leave of absence or incur other expenses and losses on account of COVID-19 (that wouldn’t have otherwise qualified for a hardship distribution).
As COVID-19 spreads across the country, workers have been instructed, and in some cases ordered, to stay home and shelter in place, with the exception of certain workers deemed essential (e.g., health care workers, food distribution and grocery store workers, transportation workers). Where workers can perform the daily duties of their jobs remotely from home, their work continues. However, some workers, particularly in the services and retail industries, just cannot work remotely. Employees facing reduced hours or furloughs will likely suffer financial hardship and may be looking for a way to access their retirement funds to relieve that stress.
Fortunately, many employer-sponsored 401(k) and 403(b) retirement plans provide for an in-service distribution right upon the showing of an immediate and heavy financial need (a “financial hardship”). Many plans have adopted safe harbor immediate and heavy financial hardship reasons, which include expenses related to medical care, payment of tuition, payments of rent or mortgage to prevent eviction, and funeral expenses. Historically, the IRS would also issue special relief for areas that suffered a disaster (e.g., a hurricane or wildfires), which allowed plan participants access to hardship distributions even if the participant did not otherwise satisfy one of the other safe harbor reasons (like a casualty loss to the participant’s principal residence), and increased plan loan limits.
Following the enactment of the Tax Cuts and Jobs Act of 2018, the IRS amended the hardship distribution regulations to reflect changes made by that Act and included a new immediate and heavy financial need safe harbor event:
Financial need incurred by an employee on account of a FEMA declared disaster.
Under the new rules, any plan participant who lives in or works in the declared disaster area and otherwise satisfies the requirements for a hardship (i.e., the amount taken is necessary to meet the need), is eligible to take a hardship for expenses and losses on account of the disaster, including loss of income. Examples of situations where hardships are now permitted include situations where employees living in the affected states face financial hardship because they have been put on an unpaid leave of absence or had their hours reduced due to COVID-19.
Before taking a hardship distribution, participants should consider all other possible sources for the needed funds. In addition to a hardship distribution being subject to income tax, if taken before age 59½, could be subject to a 10% excise tax for early distribution.
Given the present circumstances, we wanted to take the opportunity to remind plan sponsors and plan participants of the availability of these new hardship provisions. The new rules became effective as of January 1, 2019, and were permissive – so some employers may not have adopted the new disaster area hardship safe harbor. Plans do not yet have to be amended to reflect the new rules, but the plan sponsor will have to have otherwise taken appropriate action to incorporate the change into its plan.
For the most up-to-date list of states that have been declared disaster areas, visit https://www.fema.gov/disasters.
Stay safe everyone.
