The official hurricane season has just begun (the National Oceanic and Atmospheric Administration says it starts June 1). But we’ve already had a tropical system in the Atlantic (Andrea) — and that serves as a reminder that it can be helpful to a service provider and plan administrator to prepare… just in case.
The IRS offers some helpful tips and reminders, including the following.
Don’t Forget to Update Emergency Plans
Since a disaster can strike any time, be sure to review emergency plans annually. Make plans ahead of time and be sure to practice them.
Create Electronic Copies of Key Documents
Keep a duplicate set of key documents, including bank statements, tax returns, identifications and insurance policies, in a safe place such as a waterproof container and away from the original set.
Check on Fiduciary Bonds
Employers that use payroll service providers should ask the provider if it has a fiduciary bond in place. The bond could protect the employer in the event of default by the payroll service provider.
The usual hardship distribution rules generally apply even when there is a hurricane or other natural disaster; generally, there are no special rules for such times. A 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 qualify automatically.
Sometimes 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.
Treas. Reg. §1.401(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, as well as an employee’s beneficiary, even if that beneficiary is not his her spouse or dependent.
What constitutes an “immediate and heavy” financial need 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):
- certain medical expenses;
- costs relating to the purchase of a principal residence;
- tuition and related educational fees and expenses;
- payments necessary to prevent eviction from, or foreclosure on, a principal residence;
- burial or funeral expenses; and
- certain expenses for the repair of damage to the employee's principal residence.
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.
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 set 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.
There generally is no limit on when an IRA owner may take a distribution from his or her IRA — but there may be unfavorable tax consequences, such as an additional tax on early distributions. However, certain distributions from an IRA that are used for expenses similar to those that may be eligible for hardship distributions from a retirement plan are exempt from the additional tax on early distributions. Specifically, a distribution from an IRA for higher education expenses or to finance a first-time home purchase is exempt from the early distribution tax.
The IRS makes questions and answers on hardship distributions available here.