Michael A. Webb, vice president, Cammack Retirement Group, answers:
The reason you could not locate a specific reference to hardship in the final 403(b) regulations governing distributions of employer contributions to custodial accounts is that there is indeed no such reference! However, to answer your question, the Experts believe that it is important to examine what the regulation DOES state, as well as provide the historical context of the regulation.
Up until the issuance of final regulations, there were no clear distribution restrictions on employer contributions to 401(b)(1) fixed/variable annuities at all. The only statutory restrictions that applied to employer contributions were with respect to 403(b)(7) custodial accounts. It was not clear that employer contributions to a fixed/variable annuity could not be withdrawn for any reason, though many people thought that the 401(a) plan restrictions applicable to “money purchase” and “profit sharing” plans, as applicable, applied to 403(b)(1) plans as well.
The updated final 403(b) regulations, for the first time, clarified this and placed distribution restrictions on amounts invested in 403(b)(1) annuities as follows (boldface our emphasis), essentially confirming that limitations similar to the 401(a) “profit sharing” plan limitations applied:
§1.403(b)-6 Timing of distributions and benefits.“(b) Distributions from contracts other than custodial accounts or amounts attributable to section 403(b) elective deferrals. Except as provided in paragraph (c) of this section relating to distributions from custodial accounts, paragraph (d) of this section relating to distributions attributable to section 403(b) elective deferrals, §1.403(b)-4(f) (relating to correction of excess deferrals), or §1.403(b)-10(a) (relating to plan termination), a section 403(b) contract is permitted to distribute retirement benefits to the participant no earlier than upon the earlier of the participant’s severance from employment or upon the prior occurrence of some event, such as after a fixed number of years, the attainment of a stated age, or disability. See §1.401-1(b)(1)(ii) for additional guidance. This paragraph (b) does not apply to after-tax employee contributions or earnings thereon.”
So, though hardship is not specifically referenced, the term “some event” is used, which includes such non-hardship events, such as completion of a fixed number of years in the plan or attainment of a stated age. The regulations reference §1.401-1(b)(1)(ii) which also does not refer to hardship, but provide some additional reasons for distribution, as follows:
§1.401-1(b)(1)(ii) Qualified pension, profit-sharing, and stock bonus plans.
“(ii) A profit-sharing plan is a plan established and maintained by an employer to provide for the participation in his profits by his employees or their beneficiaries. The plan must provide a definite predetermined formula for allocating the contributions made to the plan among the participants and for distributing the funds accumulated under the plan after a fixed number of years, the attainment of a stated age, or upon the prior occurrence of some event such as layoff, illness, disability, retirement, death, or severance of employment. A formula for allocating the contributions among the participants is definite if, for example, it provides for an allocation in proportion to the basic compensation of each participant. A plan (whether or not it contains a definite predetermined formula for determining the profits to be shared with the employees) does not qualify under section 401(a) if the contributions to the plan are made at such times or in such amounts that the plan in operation discriminates in favor of officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees. For the rules with respect to discrimination, see §§1.401-3 https://www.law.cornell.edu/cfr/text/26/1.401-3 and 1.401-4 https://www.law.cornell.edu/cfr/text/26/1.401-4. A profit-sharing plan within the meaning of section 401 is primarily a plan of deferred compensation, but the amounts allocated to the account of a participant may be used to provide for him or his family incidental life or accident or health insurance.”
Classifying illness as an event that would permit a distribution lends additional support to the notion that the “some event” could also include financial hardship, though not explicitly stated in the regulations. If the regulation included the occurrence of non-hardship events as reasons for distribution, it would not seem reasonable that distributions could also be made for financial hardship, since a financial hardship event would be more restrictive than some of the events cited. As always, however, benefits counsel with specific expertise in this area should be consulted before allowing 403(b)(1) fixed/variable annuity employer contributions to be distributed for financial hardship.
Finally, it should be noted that after-tax and rollover contributions, as cited in the final 403(b) regulations above, are not subject to these distribution rules and thus may be withdrawn at any time if the plan so permits. However, employee contributions as a condition of employment or pursuant to a one-time irrevocable election of whether to participate in the plan (more commonly referred to as employee mandatory contributions) would be subject to these distribution rules, since only elective deferrals and custodial accounts are not subject to this regulation and instead are subject to stricter in-service distribution rules.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.