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Cold Turkey Withdrawal

11/26/2018
By Jack Towarnicky

Just in time for Thanksgiving, on November 14, 2018, the Internal Revenue Service published a notice of proposed rulemaking regarding Bipartisan Budget Act of 2018 changes that liberalized hardship withdrawals – changes that will increase leakage.1  This guidance came out exactly one week after the Department of Labor’s request for comments regarding “auto portability” – changes designed to reduce leakage.2 Getting mixed signals?  I am.

Hardship Withdrawals - Background

PSCA’s 60th Annual Survey shows that 80 percent of plans permit hardship withdrawals. Vanguard’s annual study, “How American Saves 2018,” shows that 85 percent of plans administered by Vanguard permit hardship withdrawals.3  One estimate is that .2 percent of plan assets leak due to hardship withdrawals.   If so, that would be approximately $12B.  The impact on retirement assets may be substantial.4

Currently, regulations limit hardship withdrawals to 401(k) contributions where:

  • The distribution is needed to meet an immediate and heavy financial need that cannot be relieved from other reasonably available resources. 
  • The amount of the distribution is not in excess of the amount necessary to satisfy that need (plus amounts necessary to pay taxes or penalties resulting from the distribution).
  • Where the plan applies the safe harbor requirements, six types of expenses are deemed to be an immediate and heavy financial need: (1) unreimbursed medical expenses of the participant or primary beneficiary, (2) purchase of principal residence, (3) post-secondary school tuition, fees, room and board for 12 months for an employee, spouse, child or primary beneficiary, (4) to avoid eviction or foreclosure, (5) to repair damage to a principal residence as a “casualty loss” under Code section 165, or (6) funeral expenses.
  • Under that safe harbor, an employee must first obtain all currently available distributions and nontaxable plan loans from the plan and any other plan maintained by the employer.  After the hardship distribution, all contributions are suspended for at least six months. 

Hardship Withdrawal - Changes

What’s changed regarding hardship withdrawals?

  • The 6-month prohibition on contributions following a hardship distribution was eliminated. 
  • The requirement to take all nontaxable plan loans before taking any hardship withdrawal was eliminated; however, that change is not mandatory.  Plans could continue to impose a requirement that participants take plan loans before being eligible for a hardship distribution.
  • Assets available for hardship withdrawal now include all earnings on pre-tax deferrals; this does not apply to 403(b) plans. 
  • Assets available for hardship withdrawals now include Qualified Non-Elective Contributions (QNEC) and (Qualified Matching Contributions (QMAC) account balances; this does not apply to QNECs and QMACs in 403(b) custodial accounts.
  • The “primary beneficiary” under the plan may be treated the same as a spouse or dependent with qualifying medical, educational, or funeral expenses for a hardship withdrawal.
  • Casualty losses for damage to a principal residence qualify for hardship distribution without regard to the new restrictions in Internal Revenue Code Section 165.
  • The facts and circumstances requirement is eliminated for hardship distributions on or after January 1, 2020.  A plan administrator must: (i) limit the amount of a distribution to the participant’s need (including amounts necessary to pay taxes or penalties on the distribution), (ii) verify that the participant has taken all available distributions under the employer’s plans (other than nontaxable loans), and (iii) obtain a representation from the participant that he or she has insufficient cash or other liquid assets to satisfy the need (and the plan administrator does not have actual knowledge otherwise).
  • Adds a new safe harbor reason for hardship distributions to include a federally declared disaster by the Federal Emergency Management Agency (FEMA), provided that the employee’s principal residence or principal place of employment at the time of the disaster was located in the area designated by FEMA for individual assistance due to the particular disaster. 


The changes are effective for plan years beginning after December 31, 2018, and the proposed regulations provide that they generally would apply to distributions made in plan years beginning after December 31, 2018 – unless an exception applies.  Plan sponsors should review these requirements with legal counsel and amend their plans' hardship distribution provisions in a timely fashion.

Hardship Withdrawals – Eliminated 

I have long advocated plan sponsors consider eliminating hardship withdrawals to reduce leakage.  In terms of liquidity, I have long favored 21st Century plan loan processing (electronic banking).  If there is a need for in-service withdrawals, a plan sponsor might consider adding Deemed IRAs, and/or after-tax contributions (limited as necessary to non-highly compensated employees).  Generally speaking, a plan could allow withdrawal of such after tax contributions in hardship situations.  Similarly, Deemed IRA assets are generally available at any time for any reason.   

Decades ago, in my last plan sponsor role, I eliminated hardship withdrawal provisions – coincident with improving liquidity using plan loans.  There were a few complaints.  And, no one ever acknowledged the substantial reduction in leakage nor the improved retirement preparation.  

It was a thankless task.       


1Pub. L. 115-123, 2/9/18.  See also: 83 Fed. Reg. 56763, 11/14/18, Accessed 11/20/18 at:  https://www.federalregister.gov/documents/2018/11/14/2018-24812/hardship-distributions-of-elective-contributions-qualified-matching-contributions-qualified 

2Department of Labor, Employee Benefits Security Administration, request for public comment on a Proposal Related to Retirement Asset Auto Portability designed, in part, “to reduce leakage of retirement savings from the tax-deferred retirement saving system”, 11/7/18, Accessed 11/20/18 at:  https://www.dol.gov/newsroom/releases/ebsa/ebsa20181107   See also:  Advisory Opinion, 2018-01A, November 5, 2018, Accessed 11/20/18 at:  https://www.dol.gov/sites/default/files/ebsa/employers-and-advisers/guidance/advisory-opinions/2018-01a.pdf  

3A. Munnell, A. Belbase, G. Sanzenbacher, An Analysis of Retirement Models to Improve Portability and Coverage, Figure 6, March 2018, Accessed 11/20/18 at: http://crr.bc.edu/wp-content/uploads/2018/03/Portability-and-coverage_Special-report.pdf  

4A $10,000 hardship distribution for a worker age 25 would generally provide a net, after taxes of ~$6,300 (assuming federal marginal income tax rate of 22%, state income tax rate of 5% and a 10% early withdrawal penalty tax, for a full time wage and salaried worker in the 3rd quarter 2018 ($46,124, U.S. Bureau of Labor Statistics, Accessed 11/20/18 at: https://www.bls.gov/opub/ted/2018/median-weekly-earnings-were-796-for-women-973-for-men-in-third-quarter-2018.htm

5J. Towarnicky, Impediments to Saving for Retirement – Part 2 - The Solution? The Right Kind of Liquidity, 11/9/18, Accessed 11/20/18 at: https://www.psca.org/blog_jack_2018_51   See also:  J. Towarnicky, Hardship Withdrawals – An Attractive Nuisance Becomes More Attractive, 2/9/18, Accessed 11/20/18 at: https://www.psca.org/blog_jack_2018_5  See: J. Towarnicky, Sidecar = Suboptimal, 07/30/18, Accessed 11/20/18 at: https://www.psca.org/blog_jack_2018_36 

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