Hurricane Season: Brush Up on Hardship Distributions

This summer, for the first time in more than 20 years, Hawaii was hit by a named tropical system. ays later, a second churned offshore. Hurricane Arthur splashed through North Carolina’s Outer Banks just before July 4. And the height of the Atlantic hurricane season is about to arrive. This portends the possibility of significant property losses, business disruption and the need for hardship distributions from 401(k)s.

Generally, there are no special rules for hardship distributions due to hurricanes or other natural disasters; the general hardship distribution rules apply. An employer’s benefit plan may list the specific criteria it uses to determine if a participant is eligible for a hardship distribution. Expenses for repairing damage to an employee's principal residence may automatically qualify.

Occasionally, when a hurricane or other natural disaster is especially devastating, laws are enacted that provides for special plan distributions and loans that would otherwise not be available to employees. For example, in 2005 the federal government enacted a law to help individuals and businesses affected by Hurricane Katrina, and agencies issued regulations implementing that law. 

401(k)-1(d)(3)(i) says that an early distribution from a 401(k) must be to made to meet an immediate and heavy financial need of an employee, and that the amount must be necessary to satisfy that need. That includes the needs of an employee’s spouse and dependents, and the Pension Protection Act of 2006 expanded the ability to obtain a distribution to include an employee’s beneficiary even if that beneficiary is not the employee’s spouse or dependent. 

So what is an “immediate and heavy” financial need? That depends on the facts and circumstances surrounding a specific distribution. The IRS considers the following to be immediate and heavy expenses that could justify a hardship distribution from a 401(k), which is spelled out in Treas. Reg. §1.401(k)-1(d)(3)(iii): 

A financial need may be immediate and heavy even if it was reasonably foreseeable — so presumably, if a hurricane were predicted days in advance the costs incurred as a result of it may still qualify. 

Treas. Reg. §1.401(k)-1(d)(3)(iv)(E) says that a distribution is deemed necessary to satisfy an immediate and heavy financial need of an employee if two conditions are met: 

the employee has obtained all other currently available distributions and loans under the plan and all other plans maintained by the employer; and 

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 six months after receipt of the hardship distribution. 

A hardship distribution may not exceed the amount of the employee's need. However, the amount may include what is necessary to pay any taxes or penalties that may result from the distribution.

And it is important to note that a distribution cannot be a way to address storm-related damage and at the same time preserve a savings account — Treas. Reg. §1.401(k)-1(d)(3)(iv)(B) says that the federal government does not consider a distribution of be necessary to satisfy an immediate and heavy need if the employee has other resources available to meet the need. And here the inclusion of an employee’s spouse and dependents is a double-edged sword — in setting this standard, the IRS includes not just the assets of the employee, but also those of his or her spouse and dependents.

There is no hard and fast rule regarding whether assets are considered available; that determination depends on the specific facts and circumstances of an individual case. There are, however, some assets not considered to be available; for instance, property held for an employee’s child in an irrevocable trust or under the Uniform Gifts to Minors Act.