Thought Leadership

Hurricane Relief and Retirement Fund Hardship Withdrawals

Although easier to obtain for those impacted by Harvey, hardship withdrawals should only be taken after careful consideration.

 

Executive Summary

 

The Internal Revenue Service announced the removal of restrictive rules and procedures for in-service withdrawals from employer sponsored retirement plans (e.g. 401(k) and 403(b) plans) for victims of Hurricane Harvey. The removal of these hurdles will make it easier for these individuals, and their relatives who can take distributions from their own plans, to withdraw funds to pay for damages and related expenses caused by Harvey. The relief provided only relaxes the procedural and administrative rules related to withdrawals – it does not provide any tax relief. The IRS has stated that these withdrawals will still be subject to income tax and, if applicable, penalties. Even with the ability to access these funds, retirement plan participants affected by Harvey should strongly consider utilizing and exhausting other funds first and should use hardship withdrawals from retirement plans as an absolute last resort.

 

Hardship Distribution Background

 

The rules and procedures for obtaining hardship withdrawals can be substantial and onerous. Normally, the only way for a currently employed individual to obtain an in-service withdrawal from an employer sponsored retirement plan is for it to qualify as a hardship withdrawal or to obtain a loan (except for funds attributable to rollover contributions from another plan, which may be accessible at any time if permitted by the plan).

 

Although hardship withdrawals and loans are permitted, it is not a requirement for plans to provide them. An individual who wants to take a hardship withdrawal would need to check with a benefit or plan administrator to see if the plan allows for it. Many plans do not. Even if hardship withdrawals are permitted, they will only be allowed if they are for an “immediate and heavy financial need” and will be limited to the amount necessary for that need. Not all expenses will qualify for hardship withdrawals. For example, funds to provide for temporary housing and for food will likely not qualify, while expenses to repair damage to the employee’s principal residence will.

 

Additionally, the IRS requires procedural and administrative requirements that can be quite substantial. The plan sponsor must retain documentation of hardship distribution (in either paper or electronic format) that includes:

  • Documentation of a hardship request, review and approval;
  • Financial information and documentation that substantiates the employee’s immediate and heavy financial need;
  • Documentation to support that the hardship distribution was properly made in accordance with the applicable plan provisions and the Internal Revenue Code; and
  • Proof of the actual distribution made and related Forms 1099-R.

 Hardship distributions are also subject to income taxes (unless they consist of Roth or after tax contributions). They may also be subject to a 10% additional tax on early distributions (for those under 59 ½). Employees who take a hardship distribution cannot repay it to the plan or roll it over to another plan or an IRA, and those who take a hardship distribution are banned from being able to make additional contributions to the plan for a six-month period.

 

IRS Announcement – Relaxing the Rules for Hardship Withdrawals

 

In IRS Announcement 2017-11, the IRS announced special rules regarding hardship distributions for victims of Hurricane Harvey, which temporarily removed many of the hurdles in obtaining these distributions. This relief is similar to those that were provided for other disasters such as Hurricane Matthew and Sandy, and will likely also be enacted for those who may be impacted by Hurricane Irma. The special rules focus on making it easier and faster to obtain funds than it normally would be. The relief provided by the Announcement are as follows:

  • Ability for plans which currently do not allow for hardship withdrawals and loans, to do so before the plan is amended to specifically allow it (such plans will then need to be amended by at the end of 2018).
  • Relaxed documentation requirements which allow plan sponsors to rely on the employee’s representation as to the need for hardship distribution as long as the plan administrator makes a reasonable effort, when practicable, to comply with the documentation requirement.
  • Allowing for relief to be provided for any hardship by the employee, not just those stated in the regulations.
  • A person who lives outside the disaster area can take out a retirement plan loan or hardship distribution and use it to assist a son, daughter, parent, grandparent or other dependent who live or work in the disaster area.
  • Waiver of the six month ban for being able to make continuing contributions to the plan which normally applies for individuals who receive a hardship distribution.

For these special rules to apply hardship withdrawals must be made by Jan. 31, 2018.

Planning Consideration – Hardship Withdrawals as a Last Resort

Even given the greater ease in obtaining hardship withdrawals, it should still be used as an absolute last resort. One point of emphasis made by the IRS is that these rules do not change the taxation of the withdrawals. Hardship distributions are still likely to be subject to income taxes (unless they consist of Roth and after tax contributions) and may also be subject to a 10% additional tax on early distributions. As is the case with traditional hardship withdrawals employees cannot repay amount withdrawn back to the plan or roll it over to another plan or an IRA.

Hardship withdrawals will likely result in participants paying more in income taxes, since each dollar withdrawn from a retirement plan is generally taxed as ordinary income and will likely be subject to the 10% withdrawal penalty if the participant is under the age of 59 ½. Furthermore, such withdrawals, since they cannot be put back into the plan, may negatively impact retirement goals. This negative impact is further exacerbated given the loss of the benefit of compounding growth for amounts withdrawn.

Therefore, if possible, a participant should utilize other sources of funds which they hopefully have saved for such an emergency. Given the devastation caused by Harvey, funds may still be needed from a retirement plan to repair the damages or provide for other expenses. The better option than obtaining a hardship withdrawal would be to take loans from the plan. Even if the plan currently does not allow loans per the IRS announcement, as is the case with hardship withdrawals, these plans can permit loans without having to first amend the plan. The law allows you to borrow up to $50,000 or half your vested balance, whichever is less. Loans, though, typically need to be repaid (with interest) within five years to your account.

 

Conclusion

Although the IRS has provided special rules which makes it easier for victims of Hurricane Harvey to obtain hardship distributions from an employer retirement plan to pay for expenses and repairs, such withdrawals should only be taken after careful consideration of the possible negative impacts. This is especially true since the IRS did not provide any tax relief for these types of distributions. If possible, other sources of funds should be utilized first and then loans from retirement plans, before hardship withdrawals are utilized.

 

Important Disclosures

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by First Foundation Advisors), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from First Foundation Advisors. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. First Foundation Advisors is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. If you are a First Foundation Advisors client, please remember to contact First Foundation Advisors, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the First Foundation Advisors’ current written disclosure statement discussing our advisory services and fees is available upon request. First Foundation Inc. provides two separate and distinct services: (1) investment advisory services through First Foundation Advisors, as an SEC registered investment adviser, and (2) banking, trust services and philanthropic and family consulting through First Foundation Bank and insurance services through the bank’s subsidiary, First Foundation Insurance Services. Clients may engage First Foundation for either or all services. However, no investment advisory client is required to engage First Foundation Bank for banking services, and no banking client is required to engage First Foundation Advisors for investment advisory services.

Investments made by First Foundation Advisors: Are Not FDIC Insured | Are Not Bank Guaranteed | May Lose Value