IRS Issues Additional Guidance Related to 401(k) Hardship Distribution and Child's Student Loan

On March 30, 3018, the IRS published Informational Letter 2018-0001, which responds to an inquiry as to why a 401(k) hardship distribution could not be made to pay off a child’s college student loan.

In the letter, which is a response to a Congressional inquiry, the IRS explains that 401(k) plans are intended for employees to contribute part of their pay toward retirement. To help ensure that funds in the plan are available at retirement, early withdrawals from a 401(k) plan are allowed only in cases of hardship.

As background, a 401(k) retirement plan may, but is not required to, provide for hardship distributions. The 401(k) regulations provide that a hardship distribution can only be made if the employee (or spouse or dependent) has an immediate and heavy financial need and the distribution is necessary to satisfy the financial need. If a 401(k) plan provides for hardship distributions, it must provide the specific criteria used to make the determination of hardship. For example, a plan may provide that a hardship distribution can be made only for medical or funeral expenses, but not for the purchase of a principal residence or for payment of tuition and educational expenses.

In the response, the IRS highlights that the “payment of tuition, related educational fees, and room and board expenses, for up to the next 12 months of post-secondary education” is a permissible hardship under the 401(k) regulations. However, paying off student loans would not qualify, because it’s not payment for the next 12 months of post-secondary education. The letter concludes with the possible alternative of getting a loan from the plan. A loan, unlike the hardship distribution, would be tax-free, and the participant could have up to five years to repay it.

Please note: IRS Information Letters are generally advisory and have no binding effect on the IRS. For employers, the IRS letter serves as a good reminder that the intent of a 401(k) plan is to help an employee make payments toward retirement. If a 401(k) plans allows for hardship distributions, the plan operations should strictly align with the plan terms so that the intent of the 401(k) plan may be preserved.

Informational Letter 2018-0001 »