Hardships not eligible for Rollover

[Guest Frank Jackson]

The IRS Restructuring and Reform Act of 1998 provides that hardship withdrawals are not eligible rollovers and not subject to the 20% withholding. However, I am told that this rule only applies to the elective deferral portion of the distribution. Is this true? Does anyone know of any industry publications that have addressed this issue? The effective date is 1/1/99.

[david shipp]

Section 402©(4), defining eligible rollover distributions, was amended by the IRS Restructuring Act to exclude "any hardship distribution described in section 401(k)(2)(B)(I)(IV)." That section describes distributions from profit sharing or stock bonus plans to which 402(e)(3) applies. 402(e)(3) deals with CODAs.

In reading the committee report, it appears that the concern was the possibility of taking a hardship and washing it through an IRA to avoid the 10% premature withdrawal penalty. Although this same issue applies to all hardship withdrawals, the committee report states "The bill provides that distributions from cash or deferred arrangements and similar arrangements made on account of hardship of the employee are not eligible rollover distributions." It appears that "other similar arrangements" is meant to cover TSAs. It is not unreasonable to interpret the amendment to apply only to amounts under a CODA.

This result would not be favorable from an administrative standpoint and hopefully the IRS will be engaged in discussions of the issue at upcoming seminars. There may be room to interpret the amendment more broadly.

[LCARUSI]

I agree with David that the new rule applies only to the elective deferral portion of the distribution.

But I don't understand why washing the distribution through an IRA would allow someone to avoid the 10% excise tax. Wouldn't the individual just wind up paying the 10% penalty on the distribution from the IRA instead of from the 401(k) Plan?

[Guest boetgerinc]

Directly rolling a hardship to an IRA and then taking a distribution would avoid the initial mandatory 20% withholding. Although taxes would be paid when the 1040 is filed. This is the only "advantage" that I am aware of in this situation.

[david shipp]

Sorry for not being clear on the IRA rollover. Apparently one could roll to a regular IRA and then roll to a Roth IRA to avoid the early withdrawal. (It appears that the issue was attacked both in the definition of eligible rollover and in new Roth distribution rules.)

In addition, IRAs now have a 72(t) exemption for higher education and first home purchase distributions which don't apply to 401(a) plans..

[This message has been edited by david shipp (edited 09-16-98).]