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How the CARES Act affects retirement plans

Apr 02, 2020

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law on March 27, 2020. This act is the single biggest economic relief package in American history and provides significant relief to American families, workers and businesses suffering as a result of the COVID-19 coronavirus pandemic.

Part of this $2 trillion stimulus package includes several provisions to help plan sponsors and participants of retirement plans.

Many of the key changes impacting retirement plans apply to a “qualified individual.” A qualified individual meets any one of the following tests:

  • The participant has a positive coronavirus diagnosis
  • The participant’s spouse or dependent has been diagnosed with the virus
  • The participant experiences adverse financial consequences from the impact of the virus because of one of the following:
    • The participant was laid off, furloughed, quarantined or had hours reduced
    • The participant was unable to work due to the unavailability of childcare
    • The participant’s own business has had to close or reduce hours

A plan administrator may rely on the participant’s certification that they satisfy the conditions of a qualified individual and do not need to obtain additional documentation to support the determination. 

New distribution option

The CARES Act permits a “qualified individual” to take “coronavirus-related” distributions through December 31, 2020, of up to $100,000 without the additional 10% early withdrawal penalty.

While the distribution is exempt from the 10% penalty tax, it is still subject to federal and state income tax. Participants may spread the taxes over a three-year period, and they may repay all or part of the distribution to the plan or a plan that accepts rollovers within that time frame. Any repayment of the distribution is treated as a tax-free rollover and is not adjusted for earnings.

If the distribution is not repaid within three years, the withdrawal is taxed ratably over three years starting in 2020. Since one-third of the distribution would be taxed in each year, and that the repayment may not be made until 2022, amended returns for 2020 and 2021 may be required.

It is not clear yet how repayments of coronavirus-related distributions will be handled — or the tax impact of such repayments. We are waiting for additional guidance from the IRS.

These distributions are allowable by any eligible retirement plan, including qualified plans, IRAs, 401(k)s, 403(b) plans and governmental 457(b) plans. The distributions are also available to beneficiaries of deceased participants and alternate payees of participants in these types of plans. Coronavirus-related distributions are not permitted by defined benefit or money purchase plans, as these types of plans cannot provide in-service distributions prior to age 59.5.

It is important to understand that the coronavirus-related distributions are not eligible rollover distributions, which means that they are not subject to the 20% mandatory withholding on such distributions but rather the 10% withholding, and that can be waived by the participants. Participants must receive notice that they can waive the withholding. Failure to provide that notice is subject to a $100 penalty per participant, up to a maximum of $50,000.

Increase in plan loan limits and extension of payment terms

For plans that permit participant loans, the CARES Act also permits an increase in the amount available up to 100% of a qualified individual’s vested account, up to $100,000. This provision covers loans made within 180 days of the enactment date (through September 24, 2020).

Furthermore, upon the request of a qualified individual, any existing loan payment due on any outstanding loan between March 27, 2020, and December 31, 2020, may be delayed up to one year. The five-year repayment period is also extended for one year. Interest accrues on the loan during the delay period. Loans will need to be re-amortized to reflect the interest accrual and the change in the repayment period.

It is important that plan sponsors provide accurate status updates to their recordkeepers and third-party administrators for every employee to ensure that participant loans are not reported on Form 1099R as in default during this extended repayment period. 

Required minimum distribution waiver for 2020

The CARES Act suspends all required minimum distributions (RMDs) due in 2020 from defined contribution qualified plans, 403(b) plans, IRAs and governmental 457(b) plans. If the participant’s required beginning date was in 2020 (e.g., April 1, 2020), and the plan hasn’t already distributed the first RMD, the first RMD is waived as well. If the RMD is due to death, the five-year maximum distribution period is determined disregarding 2020.

This guidance applies to all RMDs otherwise due during 2020, not just those of qualified individuals. This should prevent affected participants having to liquidate investments during the downturn in the market, permitting them time to recover value.

It is important to note that since RMDs are not required, any distribution taken by an otherwise eligible participant is eligible for rollover and will require 20% federal income tax withholding. If an RMD has already been processed in 2020, it can be rolled back into an IRA or qualified plan within 60 days of the distribution with no tax consequences, assuming it is the only non-trustee-to-trustee rollover made during the year.

In addition to providing plan participants with additional access to their retirement accounts, the CARES Act also provides plan sponsors with some much-needed relief.

Delay in defined benefit funding obligations

The due date for any required minimum contributions to defined benefit plans (including quarterly contributions) during 2020 is extended to January 1, 2021. The amount of any deferred contributions is increased by the plan’s rate of interest between the original due date for the contribution and the payment date.

Despite this relief, service providers should consider having discussions with clients now regarding options for freezing accruals or other possible plan design changes to prevent a possible significantly higher funding obligation in the following year if the market does not recover soon enough. Some plan design changes can be implemented before any employee works 1,000 hours during the year.

Department of Labor (DOL) given authority to postpone deadlines

The CARES Act gives the DOL authority under ERISA to extend deadlines for matters relating to public health emergencies. This will hopefully give rise to some extensions of Form 5500 filing deadlines.

Plan amendments: Remedial amendment period extended to 2022

Plan amendments for coronavirus-related distributions, suspended loan payments and increased loan limits (all of these are optional), as well as the RMD waivers, are available immediately, but the actual amendments would be required by the last day of the plan year beginning on or after January 1, 2022 (December 31, 2022 for December 31 year-end plans). Governmental plans have an additional two years.

The CARES Act also provides that a plan sponsor may operate the plan in accordance with the new legislation so long as a retroactive amendment is adopted by the deadline. The amendment must match what was actually done in the interim. Therefore, it is important to keep track of when provisions are implemented in the interim, and that service providers gather the information regarding any takeover plans in the coming years, to prepare an accurate amendment.

Considerations regarding hardship distributions

For plans that permit hardship distributions, changes were made to the regulations last year to add an additional hardship event for areas in which a declared FEMA emergency permits individual assistance. As of today’s writing, not all states have been declared a FEMA emergency due to the coronavirus pandemic.

If your state has been provided individual assistance, then the plan can permit this type of hardship distribution. If not, hardship distributions can still be made to 401(k) and 403(b) participants under non-safe harbor rules, and plans can be amended before the last day of the plan year to use those rules.

Have more COVID-19 or CARES Act concerns?

We’re here to help you navigate the uncertainty of the COVID-19 pandemic and its impact on your people, finances and business. We have developed a library of resources in our COVID-19 resource center to help you stabilize today and prepare for tomorrow.

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Marci Boyarski, CPA
Partner in Charge, Employee Benefit Services
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