The Tax Act’s Inadvertent Impact on 401(k) Hardship Withdrawals

Jun 14, 2018

Mark Niziak
Assistant Vice President and ERISA Attorney, Benefits Consulting Group, John Hancock Retirement Plan Services

There are currently six types of expenses that, under 401(k) safe harbor rules, would justify a hardship withdrawal. Among these so-called “deemed hardship reasons” is what the US Treasury describes as “expenses for the repair of damage to the employee’s principal residence that would qualify for the casualty deduction under [IRC] section 165 (determined without regard to whether the loss exceeds 10% of adjusted gross income).” *

If your plan incorporates this safe harbor rule, there’s something you should be aware of: Allowable home-damage expenses were severely restricted by the recently enacted Tax Cuts and Jobs Act.

An example of the inadvertent impact

In our view, this is how the new restrictions apply in the case of a home damage expense resulting from a fire to a participant’s home:

  • Previously, the repair to the participant’s principal residence resulting from a fire would have generally qualified as deductible under IRC section 165—and in turn, allowable for a hardship withdrawal.

  • But now, under the Tax Cuts and Jobs Act, a fire (as well as other casualty damage) to a home is deductible under Section 165 only if it results from a federally declared disaster.

  • Since deductibility of a casualty loss under section 165 is mandatory for a 401(k) hardship withdrawal under safe harbor rules, allowable home-damage expenses are severely restricted. No federal disaster, no eligibility.

Is your plan impacted?

This depends on whether your plan uses the deemed hardship reasons to determine an immediate and heavy financial need (“401(k) Safe Harbor Standard”). Though most plans do structure their hardship rules this way, not all do.

Of course, it’s possible that this tightening of this hardship withdrawal rule is merely an unintended consequence of the new tax legislation. If so, we would expect clarification soon from the IRS. Until then, however, we caution plans that rely on this 401(k) Safe Harbor Standard to adhere closely to the regulations now in play.

Otherwise, a distribution—no matter how important financially to a participant/homeowner—could jeopardize the qualification of the underlying plan.

* From Section 1.401(k)-1(d)(3)(iii)(B)(6) of the Treasury Regulations.

The content of this page is for general information only and is believed to be accurate and reliable as of posting date but may be subject to change. John Hancock does not provide investment, tax, plan design or legal advice. Please consult your own independent advisor as to any investment, tax, or legal statements made herein.

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These articles are not an edorsement of any particular product, service or orginization; nor are they intended to provide financial, tax or legal advice. They are intended to promote awareness and are for educational purposes only.