On Friday March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), the latest massive piece of legislation designed to provide relief to individuals and businesses affected by COVID-19, the disease caused by the novel coronavirus.
Among the multitude of financial and tax relief measures included in the CARES Act are a number of provisions designed to expand access to employer-sponsored retirement plans for those impacted by COVID-19. Plan sponsors may take immediate advantage of these changes, but have until the end of the plan year beginning on or after January 1, 2022, to adopt any necessary plan amendments incorporating these new provisions.
COVID-19 Special Distribution Rules and Expanded Plan Loan Availability
Special distribution rules and plan loan changes described below are available to “qualified individuals” under the CARES Act. A qualified individual is anyone who is diagnosed (or whose spouse or dependent is diagnosed) with COVID-19 by a test approved by the Centers for Disease Control and Prevention, or who, as a result of COVID-19, experiences adverse financial consequences due to any of the following:
- Being quarantined, furloughed, or laid off;
- Having work hours reduced;
- Being unable to work due to lack of child care;
- Closing or reducing hours of operation of a business owned or operated by the individual; or
- Other factors determined by the Treasury Secretary.
An employer can rely on an employee’s certification that he or she satisfies these conditions.
2020 Permitted Early Withdrawals
Similar to qualified disaster distributions permitted following recent federally declared disasters (e.g., hurricane relief), the CARES Act permits special relief for Qualified Individuals for distributions taken in 2020 from 401(k), 403(b), and governmental 457(b) plans. These distributions differ from normal distributions in three key respects:
- Early Withdrawal Penalty Waived. While distributions made before a participant reaches age 59½ would normally be subject to a 10% early withdrawal penalty, the CARES Act waives this penalty for up to $100,000 in distributions taken by Qualified Individuals.
- Taxation of Distribution.Instead of reporting the entire distribution as income for the 2020 taxable year, participants can instead choose to recognize the distribution as income over a three-tax-year period beginning with 2020.
- Repayment of Distributions. Participants can avoid income recognition altogether by repaying these distributions during the three year period after the distribution date, either into the plan from which they were taken or into another qualified plan as a plan-to-plan transfer. Repayments will not count against the annual contribution limit for any year in which they are made.
These advantages over ordinary hardship distributions or other distributions will likely make these disaster distributions a more attractive option for Qualified Individuals needing access to retirement funds to meet immediate needs.
Increased Plan Loan Availability
Plan sponsors have already seen an increase in participant interest in plan loans, and this interest will continue to increase given the new plan loan flexibility accorded by the CARES Act. Participant loans are generally limited to the lesser of $50,000 or 50% of the participant’s vested account balance. However, for 180 days following its enactment, the CARES Act increases this limit for loans made to Qualified Individuals, allowing loans up to the lesser of $100,000 or 100% of the participant’s vested account balance.
In addition, Qualified Individuals may defer loan repayments due in 2020 (whether for new loans or loans in existence prior to the CARES Act) for one year after the next payment due date, and this one-year repayment suspension period will not count towards the five-year maximum loan term applicable to most plan loans. Although interest will continue to accrue normally over this extended loan period, the repayments will not need to be increased make up for the suspension of repayments.
2020 Waiver of Required Minimum Distributions
The CARES Act also waives the Required Minimum Distribution (RMD) requirements for 401(k), 403(b), and governmental 457(b) plans, and individual retirement accounts (IRAs) for participants or beneficiaries who otherwise would have been required to take RMDs during the 2020 calendar year. This waiver also applies to participants who turned 70½ during 2019 but who have not already taken their first RMDs. (Note that under the new RMD rules implemented by the Setting Every Community Up for Retirement Enhancement Act of 2019 (the SECURE Act), any participants who had not attained age 70½ before January 1, 2020, are not required to begin taking RMDs until they reach age 72).
Furthermore, this waiver of RMDs also applies to any beneficiaries subject to the statutory five-year required distribution period for inherited IRAs or the ten-year period under defined contribution plans required under the SECURE Act. As with the loan repayment suspensions discussed above, this suspension of RMDs will not count against those five and ten year distribution periods, so beneficiaries can extend their distribution period to account for this suspension.
2020 Delay of Defined Benefit Plan Minimum Funding Obligations and Other Limitations
Recognizing that employers may need to direct cash payments to other sources in 2020, the CARES Act allows sponsors of single-employer defined benefit pension plans to delay any quarterly or year-end minimum required contributions due during the 2020 calendar year until January 1, 2021. Interest on such payments will still accrue at the plan’s effective interest rate for the year in which payment is made.
In addition, because pension plan funding status may decline as a result of COVID-19-related events, single employer defined benefit plan sponsors can elect to use the plan’s funded status for the plan year ending prior to January 1, 2020 for purposes of determining whether funding-related benefit restrictions (e.g., limited benefit accruals, lump sum payments and accelerated payment forms) under Code Section 436 apply.
2020 Student Loan Repayments
In an ancillary provision not necessarily limited to those impacted by COVID-19, the CARES Act also permits employers to make tax-free payments during the 2020 taxable year towards employee student loans (whether paid to the employee or to the lender). The loans must be qualified education loans incurred by the employee for the employee’s education, and are subject to the same $5,250 limit that applies to certain tax-free tuition reimbursements. We have seen a great deal of interest from employers to help employees pay off student loans, and this provision provides a tax-free way for employers to do so in 2020.
For any questions on the CARES Act, or any other COVID-19 benefits-related issues, please reach out to your contact(s) on the MMM Employee Benefits & Executive Compensation team.