By: Alison J. Cohen, Esq.

On June 20, 2024, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) released guidance in the form of Notice 2024-55 (the “Notice”) regarding two of the exceptions to the 10% additional tax on early distributions under Internal Revenue Code (the “Code”) section 72(t)(1):  emergency personal expense distributions and domestic abuse victim distributions.

The Notice is in the form of Q&As, as we’ve seen recently in guidance related to other provisions of the SECURE 2.0 Act of 2022 (“SECURE 2.0”).  While this format is easy to read, there are nonetheless missing pieces of guidance that the IRS expects to ultimately fill in with final regulations.  The Notice requests public comments with respect to Code section 72(t), not just limited to the two areas covered by the Notice.

For those of you who haven’t had the joy of actually reading Code section 72(t)(1), it basically levies an additional 10% tax on taxable distributions from qualified retirement plans, unless the distribution falls within one of several exceptions, which are outlined in Code section 72(t)(2).  One such exception – with which most of you are likely familiar – is that the additional tax does not apply to distributions made after the participant attains age 59½.

Emergency Personal Expense Distributions

Section 115 of SECURE 2.0 permits a plan to provide requesting participants with an Emergency Personal Expense Distribution (“EPED”).  This is not to be confused with the Pension-Linked Emergency Savings Accounts (“PLESAs”) distributions under section 127 of SECURE 2.0, which will not be available until 2025.  This is the kinder, gentler distribution option designed to assist participants who have an immediate need that cannot be met with their normal financial resources.  EPEDs may be made available in a 401(a), 403(b), or governmental 457(b) plan, or in an individual retirement account (“IRA”) under certain conditions.  Note: EPEDs may not be made from a defined benefit or cash balance plan.

The Notice gives insight as to what sort of facts and circumstances might qualify for an EPED.  Examples provided in the Notice include:

• Medical care, regardless of the limitations in section 213(a)
• Accident or loss of property due to casualty
• Imminent foreclosure or eviction from a primary residence
• Burial or funeral expenses
• Auto repairs
• Any other necessary emergency personal expenses.

Although the above list seems an awful lot like the hardship distribution safe harbor restrictions, the last two bullets leave the door open for other events, like a car breakdown, busted water heater, or other of life’s challenges.  The plan administrator may rely on a participant’s self-certification that they have incurred a personal expense, in the same way as is permitted with hardship distributions.

Of course, life (and the IRS) doesn’t just hand out gifts without conditions.  In the case of EPEDs, there are three restrictions:  (1) a participant may treat only one distribution as an EPED per calendar year;  (2) the maximum EPED that a participant may receive is the lesser of $1,000 or the vested balance minus $1,000; and (3) once an EPED is taken, another such distribution is not available from that same plan for three calendar years, unless the participant deposits new funds to the plan – in the form of a repayment of the distributed amount, contribution of new deferrals or employee contributions, or a combination of repayment plus new employee contributions.

The participant may repay the distributed amount directly to the plan (and the plan must permit repayment if the participant is eligible to roll over to the plan).  Alternatively, the participant can take another EPED if they have contributed additional elective deferrals and employee contributions to the plan in an amount that is at least equal to the amount that was previously distributed.

Example:  Henny Penny is about to be evicted from her chicken coop.  She takes a $1,000 EPED from the plan.  During the next year, she repays $400 of the distributed amount, and makes new salary deferral contributions equal to $600.  She is considered to have repaid the EPED and may take another distribution if she suffers another need.

If an individual is no longer eligible for the plan from which the EPED is taken, they may repay the amount to an IRA.  Any repayment, whether to the plan or an IRA, must occur within the three-year period following the EPED.

The IRS, unfortunately, is not clear about how a repayment is to be treated for tax purposes.  The Notice provides that it should be treated like a rollover (Q&A A-12(c)), but there is no clarification of the tax impact.  It is possible that the repayment constitutes an after-tax contribution.  If so, a plan that allows for EPEDs may need to track these repayments separately from other plan contributions and may also be required to permit after-tax contributions.  Alternatively, the IRS may use procedures for recontribution that have previously been issued in relation to COVID and certain federal disaster distributions.  The Notice fails to clarify this point, much to our frustration.

EPEDs are not eligible for rollover at the time they are distributed to the participant.  So, there is no requirement to provide a Code section 402(f) notice or the 20% mandatory federal withholding.

Domestic Abuse Victim Distributions

Section 314 of SECURE 2.0 permits plans to allow participants to take another type of distribution without incurring the 10% additional tax.  A domestic abuse victim distribution (“DAVD”) is a distribution made to a participant within a one-year period beginning on the date on which the participant is a victim of domestic abuse by a spouse or domestic partner.  Domestic abuse covers physical, psychological, sexual, emotional, or economic abuse and is further broadly defined in the Notice.  Like the EPED, this is totally optional for the plan sponsor to permit under the plan.

Here is where the IRS made things somewhat more complicated.  Q&A B-3 outlines which plans may offer the DAVDs and starts off following the general language of Section 314 of SECURE 2.0:  Plans that can offer DAVDs include a plan described in Code section 402(c)(8)(B), “other than a defined benefit plan or a plan to which the spousal consent requirements of sections 401(a)(11) and 417 apply”—in other words, plans subject to the Qualified Joint and Survivor Annuity (“QJSA”) rules cannot make DAVDs.   The Notice cites language from Code section 401(a)(11)(B) to clarify that “defined contribution plans that (1) do not provide 100% death benefits for surviving spouses; (2) provide benefits in the form of a life annuity; or (3) are direct or indirect transferees of a defined benefit or money purchase pension plan” may not offer DAVDs.  This means, for example, that a plan that historically received merged accounts from a money purchase plan or that offers annuities as an optional form of benefit may not offer DAVDs, even to a participant who has no transferred account or who is not subject to the QJSA rules.

Assuming you have a plan that can survive the limitations discussed above and that is willing to offer the DAVDs, the maximum distribution is the lesser of $10,000 or 50% of the vested balance of the participant.  The $10,000 amount will be subject to annual cost-of-living adjustments in future years.  Self-certification is also available for DAVDs, so no proof will need to be offered up by the participant.

Like the EPED, the DAVD is not an eligible rollover distribution. In addition, a participant may repay the DAVD any time during the following 3-year period.  Proof that the IRS can copy and paste rules from one section of the Notice to another, the same rules for repayment or rollover discussed in regard to the personal expense distribution apply here as well.  Again, the Notice does not offer answers on how the plan should treat the repayment amounts.

Final Thoughts to Consider

The IRS continues to tease out bits and pieces of insight as to how plan sponsors, TPAs, and recordkeepers are supposed to handle the new provisions from SECURE 2.0.  We continue to wait for guidance in relation to many provisions of the original SECURE Act of 2019, as well.  It is unclear when (or if) the IRS will get around to issuing final guidance.  Hopefully, that guidance will answer the remaining questions for both EPEDs and DAVDs.

While we generally discourage clients from adopting provisions for which significant guidance is still pending, we realize that it’s unfair to make participants wait for some of these very valuable distribution options.  If your client demands to add these distribution types to its plan, proceed with caution and in good faith.  And remember:  we at Ferenczy Benefits Law Center are your ERISA solution!