Hardship Withdrawals and Participant Understanding

The new laws allow plans to provide for these withdrawals. It does not mean that the new laws allow participants to access these amounts. This distinction is important and often misunderstood by participants.

Since its passage, we’ve often used our newsletters and website to highlight how the SECURE Act changed key areas for plan sponsors. In doing so, we’ve focused on recordkeeping requirements and required minimum distributions. Yet, one topic that continues to come up for participants is the new rules concerning hardship withdrawals. The SECURE Act changed both the amount and the manner of obtaining such withdrawals. News coverage may have highlighted the ease of obtaining these funds which may have stemmed mostly from the new requirements for a participant to self-certify the need for the withdrawal and that the amount is not in excess of the need, rather than looking to a third party to fulfill that requirement.[1] Additionally, the SECURE Act also allowed plan sponsors to permit larger loans as part of a disaster distribution.[2]

And this loosening of the certification rules concerning hardship withdrawals is not limited to 401(k) plans. “Previously, 403(b) plans had more restrictions on the types of funds available for hardship withdrawals. However, for plan years beginning after December 31, 2023, 403(b) plans align with 401(k) plans, allowing hardship withdrawals of employer contributions and historical earnings. The simplified self-certification rules are also extended to 403(b) plans.”[3]

2023 saw record high numbers of hardship withdrawals.[4] This may be due to an increase in the media coverage of them. It could also be due to a reduction in stigma around such withdrawals. For example, the New York Times[5]reported in late 2022 that hardship withdrawals from workplace retirement accounts rose by 24% between September 2021 and September 2022. Yet, this reporting may have reduced the stigma of making such a withdrawal. As Americans learned of their increased use, there may have been a sense of safety in numbers.[6] The increased use of withdrawals may be due not just to the reduced paperwork involved with obtaining them, but the coverage of the reduced paperwork. In other words, participants may not have been as familiar with the option prior to the SECURE Act.

As we’ve written before, participants may focus more on what they hear and not what is in your plan. Participants may hear that new regulations allow for disaster loans of up to $100,000 and interpret this information as allowing the participant to apply for that amount. Instead, the new rule allows plans to include new provisions for increased emergency withdrawals based on disasters. In other words, participants may not understand how the changes to retirement laws impact them. The new laws allow plans to provide for these withdrawals. It does not mean that the new laws allow participants to access these amounts. This distinction is important and often misunderstood by participants. The allowance for them is permissive not mandatory. If a plan does not provide for such withdrawals, they will not be available to a participant. This may mean that plan sponsors may need to be proactive in explaining what kinds of withdrawals are permitted by the retirement plan.

However, new rules provide that an employer or plan sponsor may add a disaster related hardship withdrawal to a plan after such an event occurs. “An employer may choose to add this disaster-relief safe harbor to the plan at a later date (for example, when such a disaster occurs), provided that the amendment to permit the disaster-relief safe harbor is adopted by the end of the plan year in which it is effective.”[7] Another area where plan participants may be confused may be the distinction in maximum amounts between hardship withdrawals and emergency withdrawals for natural disasters.

Additionally, employees may be confused between hardship withdrawals and loans. According to the IRS, “A hardship distribution is a withdrawal from a participant’s elective deferral account made because of an immediate and heavy financial need and limited to the amount necessary to satisfy that financial need. The money is taxed to the participant and is not paid back to the borrower’s account.” In contrast, “A retirement plan loan must be paid back to the borrower’s retirement account under the plan. The money is not taxed if loan meets the rules and the repayment schedule is followed.”[8] As with hardship withdrawals, loans are permissive not mandatory.

[1] https://www.bcgbenefits.com/blog/secure-act-get-your-forms-ready

[2] https://www.benefitslawadvisor.com/2023/02/articles/secure-2-0/secure-2-0-series-part-10-emergencies-hardships-and-disasters-not-to-worry-we-have-you-covered

[3] https://www.marshmma.com/us/insights/details/simplifying-hardship-distributions-under-secure-2-act.html

[4] https://money.usnews.com/money/retirement/401ks/articles/401k-hardship-withdrawals-hit-record-high#:~

[5] https://www.nytimes.com/2022/12/16/your-money/hardship-early-401k-withdrawal-loans.html

[6] In their July 2020 article “Financial Knowledge Overconfidence and Early Withdrawals from Retirement Accounts” Sunwoo Tessa Lee and Sherman Hanna suggest that the 2019 changes to hardship withdrawals by the IRS would increase the rates of use. It may be that the additional removal of barriers to these withdrawals could similarly predict another increase in the rates of use.

[7] https://www.voya.com/voya-insights/irs-finalizes-rules-hardship-withdrawals#

[8] https://www.irs.gov/retirement-plans/hardships-early-withdrawals-and-loans

These articles are prepared for general purposes and are not intended to provide advice or encourage specific behavior. Before taking any action, Advisors and Plan Sponsors should consult with their compliance, finance and legal teams.

Back to Blog

Latest Entries

Need a Proposal?

Before leaping into the unknown, we recommend a thorough examination of your plan. Because we are experts in the field, we know the marketplace and know what your existing vendor is capable of offering.  Through this examination, we can help you optimize the service you receive.

get xpress proposal