What are the new safe harbor rules for hardship distributions under the final 401(k) and 401(m) regulations? When may these rules be utilized?
Rev. 01/26/06, E-mail Alert 2006-2

The final 401(k) and 401(m) regulations, which become effective for plan years that begin after December 31, 2005, add two new hardship events to the current four safe harbor hardship reasons that may be used by prototype plan documents. The expanded safe harbor deemed hardship list now will also include:

• Funeral expenses of a parent, spouse, child or dependent.
• Certain expenses related to the repair of damage to the participant's principal residence that would qualify for a casualty deduction on the individual's federal income tax return. For example, this would include expenses incurred to repair property damage that resulted from a natural disaster, flood damage or other loss. (The amount that may be included in the hardship withdrawal is determined without regard to whether the loss exceeds 10% of adjusted gross income.)
  

The two new safe harbor reasons may be added operationally for plan years beginning after December 31, 2005, provided the plan is amended to incorporate appropriate language by the end of the plan year in which these provisions are first utilized. Last month, in Notice 2005-95, the IRS announced that it will not be providing a sample amendment related to the incorporation of final 401(k) and 401(m) regulations. Therefore, McKay Hochman Co., Inc. will provide a good faith amendment to our clients shortly so they can implement the final regulations (including the hardship withdrawal changes).

Note: Retirement plans had the option to apply the final 401(k) and 401(m) regulations for plan years that ended after December 29, 2004 and before 2006. However, the IRS required that all the final regulations would have to be followed if earlier adoption occurred.

For a more in-depth article on the hardship rules included in the final regulations, click here.

The other four hardship safe harbor reasons are:

1. Medical expenses described under Code §213(d) incurred or anticipated to be incurred by the employee, the employee's spouse or dependent. This is for all deductible medical expenses, not just the amounts that actually exceed 7.5% of adjusted gross income.
2. Purchase (excluding mortgage payments) of a principal residence of the employee.
3. Tuition and related educational fees for the next 12 months for post-secondary education for the employee, spouse, children or dependents.
4. Payment to prevent eviction from the employee's primary residence or foreclosure on the mortgage of the employee's primary residence.