Ask Matt on Tax Reform: What Clients in Disaster Zones Need to Know
In a new series, retirement and wealth strategies expert Matt Sommer answers questions from advisors on market events, legislation and trends that may impact their clients’ investments.
What are the new employer-sponsored retirement hardship distribution rules and when do they become effective?
With a year of hurricanes, mudslides and wildfires behind us, many Americans are unsure from where to access vital funds to keep their homes and families secure following natural disasters. Retirement plans may, but are not required to, provide for hardship distributions. Many plans that provide for elective deferrals allows for hardship distributions including 401(k), 403(b) and 457(b).
Recently enacted legislation will impact hardship distributions from employer-sponsored retirement plans in two ways. First, the Tax Cuts and Jobs Act contained a provision that, for tax years 2018 through 2025, a casualty deduction is only available for losses attributable to a federally declared disaster zone. So far in 2018 disasters include flooding and mud and debris flows in California to the Harbor Bay Fire in Texas1.
This change in definition limits a plan using the safe harbor reasons for a hardship distribution effective January 1, 2018. For example, under the new law, a plan participant who experiences a total loss to his or her primary residence due to a fire that was not connected to a federally declared disaster would not qualify to receive a hardship distribution.
Second, the Bipartisan Budget Act of 2018 changed the hardship distribution rules effective for plan years beginning after December 31, 2018. The changes include a repeal of the six-month prohibition on making contributions following a hardship withdrawal. The new law also permits hardship distributions to include earnings attributable to employee deferrals, allowing qualified matching contributions and qualified non-elective contributions, as well as earnings attributable to those contributions, to be eligible for a hardship withdrawal. Finally, there is the repeal of the provision that requires employees to first obtain all nontaxable loans available under the plan before qualifying for a hardship withdrawal, giving employees greater flexibility on how to fund post-disaster projects.
As a reminder, hardship distributions are subject to ordinary income taxes and a 10% premature distribution penalty, which generally applies if under age 59 ½. Participants should carefully weigh all of their liquidity alternatives in the event of an emergency.
The information contained herein is for educational purposes only and should not be construed as financial, legal or tax advice. Circumstances may change over time so it may be appropriate to evaluate strategy with the assistance of a professional advisor. Federal and state laws and regulations are complex and subject to change. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of the information provided. Janus Henderson does not have information related to and does not review or verify particular financial or tax situations, and is not liable for use of, or any position taken in reliance on, such information.
A retirement account should be considered a long-term investment. Retirement accounts generally have expenses and account fees, which may impact the value of the account. Non-qualified withdrawals may be subject to taxes and penalties. For more detailed information about taxes, consult a tax attorney or accountant for advice.