CARES Act Loosens Retirement Plan Rules Amid COVID-19 Crisis

COVID-19
March 30, 2020
 

In an attempt to offer financial relief to individuals and employers impacted by COVID-19, Congress included provisions in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) that would affect retirement plans. This First Alert is intended to provide an overview of the main changes. This summary is preliminary in nature, though, because guidance from the IRS and other regulatory agencies will be required to clarify certain aspects of the changes involved.

Although employers will need to make decisions regarding these changes and implement some of them very rapidly, plan amendments to reflect those decisions will not need to be made until the end of the 2022 plan year (December 31, 2022 for calendar-year plans) and two years later for governmental plans.

Penalty-Free Coronavirus-Related Distributions

For 2020, qualifying individuals can take a coronavirus-related distribution of up to $100,000 from eligible retirement plans without the 10% early withdrawal penalty that typically applies for distributions before the age of 59.5 under Section 72(t) of the Internal Revenue Code (Code).

What individuals are qualified to take this distribution?

  • Individuals who are diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention;
  • Individuals with spouses or dependents who have the disease;
  • Individuals experiencing adverse financial consequences from:
    • quarantine, furlough or layoffs,
    • having their hours cut due to the coronavirus, including the closing or reduction of hours of a business owned or operated by the individual due to the coronavirus, or
    • being unable to work because of a lack of childcare due to the coronavirus.

These individuals are referred to below as being “impacted by the coronavirus.”

What types of retirement plans may make such distributions?

Eligible retirement plans include qualified plans under Code Sections 401(a), individual retirement arrangements (IRAs) under Code Sections 408(a) or (b), annuity plans under Code Sections 403(a) and 403(b), and governmental deferred compensation plans under Code Section 457(b).

Some types of eligible retirement plans are currently subject to restrictions on making distributions before a participant has had a termination of employment. In this regard, the CARES Act expressly loosens the restrictions on in-service distributions from 401(k) plans, 403(b) plans and 457 plans and arrangements to allow such plans to make such coronavirus distributions while a participant is employed. Further guidance from the Department of Treasury and IRS may be helpful to clarify whether certain other types of eligible retirement plans (such as defined benefit pension plans) may permit coronavirus distributions to active employees as opposed to only terminated employees.

When must the distribution be made?

A coronavirus-related distribution must be made between January 1, 2020 and December 31, 2020.

What documentation does the plan administrator need as proof the individual qualifies?

The plan administrator may rely on the individual’s certification that the individual is impacted by the coronavirus and meets the criteria for receiving such distribution.

Are individuals who take a coronavirus distribution required to pay income taxes on the distributed amount?

Yes. Individuals who take such a distribution still must pay income taxes on the amount withdrawn, but the CARES Act allows individuals to spread the payment of the income taxes over a three-year period. Unless the individual elects to pay the taxes on the distribution in the year the distribution is made, any amount required to be included in gross income for the taxable year of the distribution shall be included ratably over the three taxable-year period beginning with the taxable year of distribution.

Coronavirus distributions are not subject to the mandatory 20% withholding, the direct rollover rules, or the 402(f) notice requirements typically applicable to eligible rollover distributions.

Are coronavirus distributions permitted from employer contributions as well as employee elective deferrals?

The CARES Act does not appear to limit coronavirus distributions to particular contribution sources under an eligible retirement plan. Thus, they appear to be permissible from employer contributions as well as employee contributions such as elective 401(k) deferrals.

Are employers required to revise their plans to permit such distributions?

The statutory provisions permit, but do not appear to require, employers to revise their eligible plans to allow coronavirus distributions. So, employers should have a choice regarding whether and to what extent to revise their eligible plans to permit coronavirus distributions in addition to other distributions already provided under their plans. Many employers will desire to provide access to such distributions, since they may be very helpful to participants impacted by the coronavirus, while other employers may be concerned about administrative complexities or leakage of substantial plan assets (including employer contributions) for purposes other than long-term retirement needs.

Even if an employer does not expressly amend its plan to permit separate coronavirus distributions, though, a plan participant who takes a distribution under the plan’s regular provisions (such as a hardship distribution or a distribution after termination of employment) also may be impacted by the coronavirus. In such a case, the participant still may be entitled to the advantageous tax treatment for coronavirus distributions under the CARES Act, despite the fact that the employer has not amended its plan, but we need IRS guidance to be sure of that.

Can the individual repay the amount of the coronavirus distribution?

Yes. The CARES Act provides a mechanism for individuals to effectively repay a coronavirus distribution within three years after receiving the distribution. The CARES Act permits individuals to contribute a dollar amount up to the amount of the coronavirus distribution into an eligible plan and have the contribution be treated as a direct rollover into such plan, which would not be subject to the regular contribution limits applicable to the plan involved.

It is not entirely clear, though, whether any qualified plan that allows a participant to receive coronavirus distributions will be required to accept such a repayment (though if such a plan does not, presumably the participant involved could still contribute the amounts involved into an IRA). It is also unclear at this time whether the repayments are to be treated solely as pretax contributions (even if the participant had paid taxes on the distribution) and treated the same as any other rollover contributions to the plan (such as if rollovers typically are available for withdrawal at any time under the plan). Further guidance from the regulatory agencies will be needed to clarify these points.

Retirement Plan Loans

The CARES Act temporarily increases the amount of loans an individual who is impacted by the coronavirus can take from a qualified plan, 403(a) plan or 403(b) plan without being taxed and also provides a one-year extension of time for an individual impacted by the coronavirus to repay an outstanding plan loan from such a plan without the loan becoming taxable.

How much can an individual take as a loan from his or her retirement plan?

Under the CARES Act, for the 180-day period beginning on the date the Act is enacted, an individual who is impacted by the coronavirus is permitted to take plan loans up to the lesser of $100,000 or the present value of the vested account balance without the loan being taxable. Previously, individuals could only take plan loans up to the lesser of $50,000 or 50% of the present value of the vested account balance. Note, current Department of Labor (DOL) regulations regarding permissible plan loans preclude plans from lending more than 50% of the present value of a participant’s vested account balance, unless other adequate security for the loan is provided. The CARES Act does not expressly change the adequate security requirement, so it is not yet certain how it will interact with the new provisions and the extent to which DOL will waive or adjust its regulations.

How does the one-year extension of time to repay a loan work?

For any plan participant impacted by the coronavirus who has a plan loan currently outstanding prior to the date of enactment of the CARES Act that has a repayment due during the period beginning on the date of enactment of the Act and ending December 31, 2020, such repayment due date is delayed for one year without the loan defaulting or becoming taxable. Interest will continue to accrue, however, during such delay.

Are employers required to revise their plans and plan loan procedures to permit such loans and extensions?

The statutory provisions permit, but do not appear to require, employers to revise their eligible plans and plan loan procedures to allow the increased loan amounts. It is less clear whether employers and their plans have discretion to refuse to allow participants impacted by the coronavirus to take advantage of the one-year delay in repayments on existing loans. Moreover, even if employers have such discretion, it appears that a plan may not be able to treat a participant who has delayed repayment as having had a deemed distribution of the loan balance for tax purposes. Further guidance from the regulatory agencies will be needed to clarify these points, among others.

Required Minimum Distribution (RMD) Changes

Participants who would normally be required to take an RMD from a defined contribution plan (such as a 401(k) plan or IRA) for 2020 or to begin taking RMDs in 2020 are not required to receive such distributions in 2020. RMDs that normally would have been required from a defined contribution plan in 2020 to beneficiaries of deceased plan participants also are waived.

Who is impacted by this change?

This impacts any individual who started taking RMDs in 2019 or prior years and would normally have an RMD for 2020. Such individuals are not required to receive any RMD payment for the 2020 year. Also, any individual who reached age 70.5 in 2019 (and also, if provided by the plan, terminated employment during or before 2019) is not required to receive any RMD payment that would otherwise be due in 2020, including any payment normally due by April 1, 2020 (if not already paid in 2019) and the payment normally due by the end of 2020.

In addition, this provision also impacts an individual who is a beneficiary of a deceased participant in a defined contribution plan (including an inherited IRA). If such an individual would otherwise be required to receive a distribution in 2020, that distribution is waived. Moreover, if the individual is subject to the requirement that the participant’s full benefit under such a plan be distributed by the end of the fifth year after the participant’s death, 2020 will be disregarded in determining the end of the five-year period, so that it effectively becomes a six-year period.

Are employers required to revise their plans to delay distributions that otherwise would have been RMDs in 2020?

In general, the answer is likely to depend on the current plan provisions. If the plan sets forth the RMD rules in a manner that essentially incorporates those rules by reference, then the changes in the CARES Act may automatically apply to the plan and any RMDs may automatically be delayed. If the plan addresses the RMD rules in another manner, then the employer may have latitude to leave the existing plan provisions in place and make distributions at the same time as they otherwise would have been required. Regulatory guidance on this point would be helpful.

What if an individual receives a distribution during 2020 that otherwise would have been an RMD payment?

If an individual receives a distribution in 2020 from the individual's defined contribution plan that would have been an RMD but for the CARES Act, such distribution may be eligible for rollover. However, the plan administrator would not have to withhold the 20% tax, or offer a direct rollover option, or provide the special tax notice under 402(f) of the Internal Revenue Code applicable to eligible rollover distributions.

Funding Relief for Defined Benefit Pension Plans

The CARES Act also contains some relief with respect to the funding rules applicable to single employer defined benefit pension plans.

May an employer delay making minimum required contributions in 2020?

Yes, an employer that sponsors a single employer defined benefit pension plan subject to the minimum funding rules of Code Section 430 is permitted to delay making any minimum required contributions (including quarterly contributions) otherwise due in 2020 until January 1, 2021. The amount of any such delayed contributions will accrue interest. This provision may be of great assistance to companies facing cash flow issues during 2020 as a result of the coronavirus and related declines in business activity. Note, though, that this provision does not apply to contributions due to multiemployer pension plans. Also, it only applies to the minimum required contributions mandated under Code Section 430, not to any contributions required for other reasons, such as under a collective bargaining agreement.

Is any relief provided for 2020 in applying the benefit restrictions in Code Section 436?

Yes. Code Section 436 can require single employer defined benefit pension plans that fall below certain funding levels (measured based on the plan’s “adjusted funding target attainment percentage”) to impose certain benefit restrictions, such as limitations on future benefit accruals and providing lump sum distributions. The CARES Act gives an employer sponsoring such a plan the option to use the plan’s adjusted funding target attainment percentage for the last plan year ending before January 1, 2020, as the adjusted funding target attainment percentage for any plan years that include calendar year 2020. This provision should allow the adjusted funding target attainment percentage for plan years falling within 2020 to be determined as of a time before the recent steep declines in the financial markets, thus reducing the likelihood that the plan involved will be required to implement benefit restrictions under Code Section 436 for such plan years.

What should plan sponsors do now?

Plan sponsors should consider the impact of the CARES Act changes, including whether they want to amend their plans to apply the discretionary portions of the relief, such as allowing participants who might be adversely impacted by the coronavirus to take coronavirus distributions and coronavirus loans. These changes can benefit employees and other plan participants, and many employers may choose to adopt them, but the changes may also create administrative complexities. Therefore, we recommend you discuss any plan changes with your ERISA counsel as well as any recordkeeper or administrator before implementing any changes. The decisions involved and any changes in plan administration may need to occur very soon (as soon as April 1 in some cases). However, plan amendments officially reflecting any changes being made can be adopted as late as the end of the 2022 plan year (December 31, 2022 for calendar year plans) and two years later for governmental plans. Plan sponsors should also watch for further regulatory guidance and First Alerts regarding these changes, as well as for possible further legislation from Congress in response to the coronavirus pandemic.


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