Treasury and the
IRS issued rules that will expand employees' access to their 401(k) funds in
cases of financial hardship
Sep 30, 2019 @ 2:28 pm By Greg
Iacurci
Final rules issued
recently by federal regulators make it easier for 401(k) participants to
withdraw their retirement savings early in the event of a hardship, which could
have the effect of increasing so-called leakage from
workplace retirement plans but may also encourage hesitant employees to boost
their 401(k) savings.
Participants in
401(k) plans are able to tap their accounts if they experience financial
hardships such as medical and educational costs and costs associated with
purchase of a primary residence. The Treasury Department and the Internal
Revenue Service issued final rules this month
that both expand the circumstances under which participants can get a hardship
distribution and allow them to access a greater portion of their 401(k) funds.
"The final
regulations make it easier for participants to access hardship distributions —
in both direct and indirect ways," said Jennifer Rigterink, an attorney at
law firm Proskauer Rose.
Hardship distributions
are a somewhat controversial topic in retirement policy circles. About 80% of
401(k) plans allow for them. Just 2.3% of 401(k) participants take hardship
distributions.
Some observers say
hardship distributions should be discouraged since they are a form of leakage,
meaning they lead to money flowing out of a 401(k) plan prior to participants'
retirement and thereby diminish their retirement savings. Participants must pay
income tax on the withdrawal, as well as a 10% penalty if they pull the money
out before they've reached age 59½.
Each year, roughly
1.5% of assets leak out of 401(k) plans and individual retirement accounts
before investors reach retirement age, the Center for Retirement Research at
Boston College found in a 2015 paper. This leakage reduces aggregate age-60
retirement assets by more than 20%, according to the center.
However, others
think making it potentially easier to tap savings could prove beneficial
because it could encourage more employees to participate in workplace
retirement plans if they know they'll be able to access their money if
necessary.
"It's the
absolute worst thing to do [from a savings standpoint]," lawyer Charles
Humphrey said, citing the tax ramifications. "It's a bad deal."
"But on the
other hand, maybe people wouldn't contribute if they felt like they don't have
a safety valve," added Mr. Humphrey, a former attorney at the IRS and
Department of Labor.
Under current
rules, employees can't make 401(k) contributions for six months after they take
a hardship distribution. That, experts said, likely dissuades some participants
from taking a hardship withdrawal since they're then unable to immediately
replenish their retirement account.
The new rules,
largely in line with proposed hardship rules issued in November 2018, require
employers to eliminate that six-month suspension — so employees can continue
making 401(k) contributions again despite taking a hardship withdrawal.
"I think
participants had to make a potentially hard choice," said Teresa Napoli,
an attorney at law firm Sidley Austin. "They don't have to make that tough
decision anymore."
In addition, the
old rules said 401(k) plan sponsors had to require participants to take a plan
loan first before they were able to request a hardship distribution. Experts
say 401(k) loans are a better financial choice for participants since taxes
aren't owed on the loan if it's paid back on time, and participants must pay
themselves back, with interest, over time.
New rules, however,
which take effect in January 2020, allow plan sponsors to scrap this
requirement.
The rules, issued
last Monday, also allow participants to access employer matching contributions,
employer nonelective contributions (a profit share, for example) and investment
earnings for hardship distributions, in addition to employee contributions.
Previous rules only allowed participants to tap their own contributions to the
plan.
"It's a big
deal, because it opens up a lot more money available for a hardship
distribution," Mr. Humphrey said.
However, it's tough
to say how many plan sponsors will voluntarily change these elements of plan
design that could encourage more leakage, experts said.
"It will
depend on the plan sponsor and their goals for the retirement plan," Ms.
Napoli said.
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