“Our plan allows for hardship distributions and follows the safe harbor, including the six-month suspension of contributions following a hardship distribution. I know that I need to suspend the elective deferrals, but what about the mandatory contributions? Should those be suspended as well?”
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:
This is an interesting question, particularly when one reviews the relevant IRS regulations. First of all, the “relevant regulations” are not the final 403(b) regulations, as one would expect, but 401(k) regulations that address hardship distributions since the final 403(b) regulations incorporate the 401(k) regulations by reference. Specifically, we must look at Treas. Reg. Section 1.401(k)-1(d)(3)(iv)(E), as follows (boldface text is the Experts’ emphasis):
(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 employee stock ownership (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; and
(2) The employee is prohibited, under the terms of the plan or an otherwise legally enforceable agreement, from making elective contributions and employee contributions to the plan and all other plans maintained by the employer for at least 6 months after receipt of the hardship distribution.
We know that mandatory contributions are not, by definition, elective contributions, so we are left with the issue of whether or not mandatory contributions are “employee contributions.” Now, it would be great if Code Section 401(k) or the relevant regulations defined “employee contributions,” but they do not. However, the 401(k) regulations, as well as the 403(b) regulations do refer to employee contributions as after-tax contributions of the type that are subject to 401(m) testing and the Internal Revenue Manual includes a chart that defines employee contributions, sometimes referred to as “after-tax” employee contributions, as “Plan contributions from employees allocated to a separate account that are:
- mandatory (they’re required to receive some benefit from the employer, such as matching contributions) or voluntary;
- treated at the time of contribution as after-tax employee contributions;
- not designated Roth contributions, loan repayments, repayments for the buy-back of cashed-out benefits (see IRC 411(a)(7)(C)), or amounts transferred or rolled over from another plan or IRA.”
Thus, it would appear that employee contributions would generally include both voluntary and mandatory after-tax contributions. However, the far more common type of mandatory contribution in a 403(b) plan is a pre-tax contribution that is either a condition of employment or pursuant to a one-time irrevocable election of whether or not to participate in the plan. These contributions, since they are not explicitly included in the definition of employee contributions in the manual, and are not referenced as employee contributions in the 401(k) and 403(b) regulations, would appear NOT to be subject to the six-month suspension requirement for hardship distributions, which would be consistent with the concept that such contributions are mandatory/irrevocable.
We note that the Bipartisan Budget Act of 2018 eliminated the six-month suspension period cited in the regulations above, effective for plan years beginning on and after January 1, 2019. The IRS has just issued a notice of proposed rulemaking to that effect.
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.
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