“Are participants required to take regular distributions from the rollover and after-tax amounts (thus, subjecting them to 20% required withholding of taxable amounts) before they can take a hardship distribution? Also, if the participant qualifies for an in-service distribution of any type of contribution after age 59 1/2, would a distribution ever qualify as a hardship distribution and the reduced withholding amount?”
Stacey Bradford, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:
Since your plan is choosing to follow the safe harbor for hardship distributions (as most plans do) we will need to turn to the safe harbor in the 401(k) regulations, since the 403(b) regulations incorporate this safe harbor by reference. Reg. §1.401(k)-1(d)(3)(iv)(E) states the following (boldface text reflects the Experts emphasis) in relevant part:
“(E) Distribution deemed necessary to satisfy immediate and heavy financial need. A distribution is deemed necessary to satisfy an immediate and heavy financial need of an employee if each of the following requirements are satisfied –
(1) The employee has obtained all other currently available distributions (including distribution of ESOP dividends under section 404(k), but not hardship distributions) and nontaxable (at the time of the loan) loans, under the plan and all other plans maintained by the employer ….”
Thus, in your example, indeed distributions from rollover and/or after-tax amounts would be required to be taken to satisfy a need prior to taking a hardship distribution. Note that the Bipartisan Budget Act of 2018 amended Code Section 401(k) to eliminate the requirement that all loans under all retirement plans maintained by the employer be exhausted prior to taking a hardship distribution, but the Act was silent on other distributions, so until further guidance is issued, the requirement for all distributions to be exhausted from all retirement plans of an employer prior to a hardship distribution remains in effect.
As for your other question, there is nothing in the Code or Regs. that states that retirement plan triggering events (events which “trigger” the ability to take a distribution) are mutually exclusive. For example, a disabled terminated employee can take a distribution either due to disability or termination of employment if a plan permits distributions under both circumstances. That said, while a participant who is age 59 1/2 and has a qualifying hardship could otherwise withdraw funds either for reasons of financial hardship OR age 59 1/2 the rule stated above requiring the employee to obtain all other currently available distributions would apply.
Therefore, the distribution would be subject to the rules for a distribution at age 59 1/2, rather than for reasons of financial hardship. (Of course, a disabled participant will also often have terminated employment, and taking a distribution on termination of employment is generally simpler to administer, so that is what is usually taken.) Finally, as a reminder, amounts attributable to employer contributions that have ever been invested in a 403(b)(7) custodial account (mutual fund) are not eligible for hardship distribution, so the participant in your scenario would not have the hardship option with respect to those amounts.
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.