403(b) Outlook: Hardship Withdrawals
December 17, 2008
What is the rule? The IRC imposes limitations on in-service distributions from 403(b) retirement plans. However, distributions of certain 403(b) accumulations may be permitted when required to meet the financial burden of a qualifying hardship of participants and their dependents. Qualifying hardship events include:
- Medical expenses (that are deductible) incurred by the employee, spouse or dependents
- Purchase of the employee's principal residence
- Payment of the next 12 months of post-secondary tuition and related educational fees, including books, for the employee, spouse or dependents
- Preventing eviction from the employee's principal residence or foreclosure of a mortgage on the principal residence
- Payments for burial or funeral expenses for the employee's parent, spouse, child or dependent
- Expenses incurred as the result of certain casualty damage to the employee's principal residence
Prior to taking a hardship withdrawal, the participant may be required to first obtain all loans and distributions available under all plans of the employer (and any related employer). And employee contributions may have to be suspended for six months following the distribution. If the loan or distribution does not meet the participant's needs, then he or she can take a hardship withdrawal. These withdrawals are subject to income tax, as well as possible early withdrawal penalties.
Responsibilities for hardship administration under the final 403(b) regulations
Effective Jan. 1, 2009, the final 403(b) regulations provide that hardship distributions from 403(b) plans will be subject to the same rules and restrictions that apply to 401(k) plans. These rules are set forth in the 401(k) regulations. The final 403(b) regulations also make it clear that the determination of whether an employee has had a hardship that would entitle them to receive a distribution is the employer's ultimate responsibility, and that it will be inappropriate for the employer to allocate responsibility for determining eligibility for hardship distributions to participants, as they lack the necessary expertise and objectivity.
Hardship administration for non-ERISA salary reduction plans
Under a safe harbor spelled out in a Department of Labor (DOL) regulation, a 403(b) plan funded solely with employee elective deferrals is exempt from ERISA if certain conditions are satisfied. One of the requirements under these regulations is that employer involvement in the plan operation must be limited to ministerial duties. The DOL has issued guidance indicating that it would be inconsistent with the safe harbor for the employer to have responsibility for making discretionary decisions in administering the program. Determination of hardship by an employer under the employee representation method is a discretionary act that would subject an otherwise exempt plan to ERISA.
Additional Department of Labor (DOL) guidance on this ERISA exemption issued at the same time as the final 403(b) regulations indicates that 403(b) salary reduction plans can still be exempt from ERISA, even though they must now satisfy the written plan requirement of the new regulations, if, among other things, the involvement of the employer is limited to certain optional specified activities. The employer cannot, however, have responsibility for, or make, discretionary determinations, such as determinations regarding hardship distributions, in administering their TDA plan if they want to retain their non-ERISA status.
What has changed? Formerly, plans may have allowed participants to make final determinations as to their eligibility for hardships. If you currently allow employees to determine whether they are eligible for a hardship, you will need to review your current practice for determining hardship and possibly adopt new administrative procedures, which may include allocating the hardship determination to a third-party. Additionally, if you have a non-ERISA salary reduction plan, be careful that you do not perform any discretionary act that may jeopardize your non-ERISA status, including making hardship determinations for your participants. Keep in mind that governmental 403(b) plans are always exempt from ERISA irrespective of the employer involvement in the plan's administration.
How TIAA-CREF helps: TIAA-CREF's Compliance Coordinator, a web-based application, will allow retirement plan sponsors to proactively manage plan participant hardship withdrawal (and loan) requests as required by the final regulations. The application was conceived by TIAA-CREF and will be developed in partnership with and hosted by Advent Software (NASDAQ: ADVS), a leading provider of software and services to the investment management industry.
Effective date: Jan. 1, 2009
What happens if you fail to comply? If hardship distributions are not properly administered, the result could be a loss of tax deferral for all contracts purchased for the affected individual. For non-ERISA TDA plans, involvement of the plan sponsor in making certain discretionary determinations may make the plan subject to ERISA.
Next week's issue: 2009 Contribution Limits