Sometimes when new tax laws, such as the recent Tax Cuts and Jobs Act (TCJA), are enacted, there are so many moving parts that unintended consequences may arise in practice.
This seems to be the case with respect to a revision to the personal casualty loss deduction under Internal Revenue Code Section 165, which will impact 401k plans and 403b plans that follow the “safe harbor” standards for allowing participants to receive hardship distributions.
The hardship distribution safe harbor regulations include a list of events that are deemed to be on account of an “immediate and heavy financial need,” including “expenses for the repair of damage to the employee’s principal residence that would qualify for the casualty deduction under Section 165 (determined without regard to whether the loss exceeds 10 percent of adjusted gross income).”1
TCJA, however, amends Section 165 to provide that personal casualty losses are deductible only to the extent such losses are attributable to a federally declared disaster (i.e., a disaster that is determined by the president to warrant federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act).
The upshot is that, based on the TCJA language and existing regulations, it appears that qualified hardship withdrawals to repair a severely damaged principal residence are effectively eliminated unless in a federally declared disaster area.
Assuming this is an unintended consequence (retirement industry groups have pointed out that there is no indication that Congress intended for the change to Section 165 to affect hardship distributions from retirement plans), this may be addressed in subsequent guidance, either as part of a technical corrections bill or in another format.
In the meantime, any plans that follow the safe harbor standards for approving hardship distributions should take the amended Section 165 into consideration.
Jon Vogler is senior analyst of Retirement Research with Invesco Consulting.
1 Source: Electronic Code of Federal Regulations, Treas. Reg. Section 1.401(k)-1(d)(3)(iii)(B)(6)
Jon Vogler was a senior analyst of Retirement Research with Invesco Consulting. Jon is a an experienced professional with specialized expertise in ERISA, offering a strong background in writing and editing, as well as comprehensive legislative and regulatory analysis.
