On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, the third piece of recent legislation passed in response to the ongoing, global COVID-19 crisis. The latest pandemic-related legislation contains a number of provisions that directly affect 401(k) retirement plans, including provisions intended to grant ease of access to 401(k) plan accounts by plan participants affected by the crisis. Click here for a discussion of other 401(k) plan issues related to the COVID-19 crisis.
DEADLINE FOR MAKING 2019 CONTRIBUTIONS IS EXTENDED: Although not part of the CARES Act, the IRS separately announced in Notice 2020-18 and related Q&As that, because the Federal income tax filing date has been moved to July 15, 2020, in response to the COVID-19 crisis, the deadline for making contributions to defined contribution pension plans (including 401(k) plans) is also extended. In other words, 401(k) plan sponsors now have until July 15, 2020, (as opposed to April 15, 2020) to make their 401(k) contributions for the 2019 plan year.
The following is a brief description of the CARES Act provisions affecting 401(k) plans:
Expanded Access to Penalty-Free Withdrawals. The previously existing rules regarding hardship withdrawals from qualified retirement plans, including 401(k) plans, already can be put to use to permit some 401(k) plan participants to access their plan accounts to pay medical and certain other expenses related to COVID-19 (click here for more information). However, the CARES Act significantly expands the rules regarding penalty-free withdrawals specifically in response to COVID-19-related expenses, and also adds its own conditions.
Under the new rules, eligible individuals may withdraw penalty-free up to a total of $100,000 from their retirement accounts in a “coronavirus-related distribution.”
Coronavirus-Related Distributions. For these purposes, a “coronavirus-related distribution” is a distribution made during 2020 to an individual (a “qualified individual”):
- Who is diagnosed with either SRS-COV-2 or COVID-19 by a test approved by the US Centers for Disease Control and Prevention (“CDC”); or
- Whose spouse or eligible dependent is diagnosed with either one of the above two diseases; or
- Who, due to either one of the above two viruses or diseases:
- Experiences adverse financial consequences as a result of being quarantined, furloughed, or laid-off; or
- Has his or her work hours reduced; or
- Is unable to work due to the lack of childcare; or
- Who is subject to other factors, as may be determined by the Secretary of the Treasury.
Permissible Repayments. Participants are permitted to repay the distributed amount at any time within three years from the date of receipt of the “coronavirus-related distribution.” For tax purposes, repayments made within the three-year period are treated as though they were direct-trustee to-trustee transfers of eligible rollover distributions, thus avoiding taxation.
Participant Certifications. Plan administrators are permitted to rely on a participant’s certification that he or she satisfies the above conditions as to whether any distribution meets the requirements of a “coronavirus-related distribution.”
BEST PRACTICE: Plan administrators should always obtain these participant certifications in writing and retain copies in accordance with their document retention policies. Click here for more details.
Taxation Issues. Distributions meeting the above requirements are treated as hardship withdrawals and are not subject to the otherwise applicable 10% penalty tax. They are, however, subject to regular income taxation. To help soften the blow, the CARES Act generally spreads the income out over a three-year period, beginning with the 2020 tax year, unless a participant elects otherwise.
OBSERVATION: It appears that the participant can avoid income taxation entirely by repaying the entire amount of the withdrawal within the three-year period beginning on the date of the withdrawal (see “Permissible Repayments,” above).
Plan Loan Limits Temporarily Doubled for Qualified Individuals. Secondly, the CARES Act temporarily modifies the rules regarding 401(k) plan participant loans by essentially doubling both the previously existing dollar limit, and the percentage limit, in the case of loans made to “qualified individuals.”
For the 180-day period beginning on the date of enactment (March 27, 2020), and solely with respect to loans made to a “qualified individual,” the maximum amount that an individual may borrow from his or her 401(k) plan account (reduced by the outstanding amount of any previous loans taken from the plan) is the lesser of:
- $100,000 (up from $50,000); or
- 100 percent of his or her vested account balance (up from 50 percent of the vested account balance).
For these purposes, a “qualified individual” is a plan participant who meets the qualifications listed in bullet points under “Coronavirus-Related Distributions,” above. (These are the same qualifications required to qualify for the CARES Act’s expanded access to penalty-fee withdrawals.)
Delayed Loan Repayment. In a related plan loan provision, if a plan loan repayment is due between March 27, 2020, and before the end of the year 2020, then the CARES Act allows the repayment to be delayed for one year, measured from the original due date. Subsequent loan repayments must be adjusted to reflect the delay in the 2020 repayment (including any interest accruing during that delay). The one-year delay for 2020 is disregarded for purposes of the generally applicable five-year limit on loan repayments.
Required Minimum Distributions Suspended for 2020. In general, 401(k) plan participants who are not still actively employed must begin taking required minimum distributions (“RMDs”) from their plan accounts by no later than the April 1st following the year that they attain age 72 (prior to January 1, 2020, age 70 ½). The RMD rules are essentially a revenue raising measure, meant to prevent participants from deferring paying income tax on plan distributions indefinitely.
NOTE: Although the SECURE Act raised the age from 70 ½ to 72, effective on and after January 1, 2020, participants who attained 70½ in 2019 still would have been required to take RMDs by no later than April 1, 2020. See our previous blog on the SECURE Act for more information.
The CARES Act eliminates the requirement to take RMDs for calendar year 2020 only. Policymakers behind this move have pointed to the harmful effect on 401(k) plan participants of forcing them to liquidate and remove plan assets at a time of near-record investment losses from retirement accounts.
Effective Date. The CARES Act provisions relating to 401(k) plans are generally effective for plan years beginning after December 31, 2019. The temporary expanded plan loan provisions are in effect for a 180-day period beginning on March 27, 2020, and ending on September 23, 2020.
Plan Amendments. 401(k) plan sponsors wishing to take advantage of one or more of the CARES Act’s provisions (other than the elimination of RMD’s for 2020) must amend their plans to reflect the changes by no later than the last day of the first plan year beginning on or after January 1, 2022. For example, a calendar year plan wishing to add both the expanded penalty-free withdrawal provisions and the temporary loan limit increases would have to adopt plan amendments by no later than December 31, 2022.
Comment. Congress and the Administration have not ruled out the possibility of additional legislation in the future, made in response to COVID-19, should the crisis continue to adversely affect the economy and the well-being of US citizens. Any such future legislation has the potential for making further changes applicable to 401(k) plans. As always, we will be closely monitoring this situation and will keep you advised as to future developments along these lines.
A Matter of Policy – Retirement Money, or Not? In times of economic insecurity and greatly increased unemployment, such as the US is now facing amid the COVID-19 crisis, it is understandable that the government would want to open up as many avenues as possible in an effort to loosen up cash to hurting Americans. In that light, granting 401(k) plan participants easier access to their retirement savings – especially given the unforeseeable nature of this emergency – undeniably makes sense. Arguably, nobody should be forced to fall behind on their mortgage, or enter bankruptcy due to medical bills, if this result could be avoided by giving employees easier access to their hard-earned retirement savings.
Nevertheless, 401(k) plans were originally intended to be retirement vehicles – and over time they have largely become the main source of retirement income in this country. More traditional defined benefit pension plans, paying monthly benefits over a participant’s lifetime, are less and less prominent. Social Security benefits are not – and were never intended to be – sufficient to sustain people during their golden years.
Further, 401(k) plans rely on the principle of long-term savings, and the compounding of interest and investment earnings over several decades, in order to produce a large enough sum of money at retirement age. When 401(k) plan balances are reduced during a worker’s course of employment by loans, hardship withdrawals, and other distributions taken prior to retirement age – necessary though these might seem at the time – there is the risk of having insufficient money once retirement comes.
While reacting to the present crisis, legislators, employee benefits professionals, and plan participants should take care to avoid creating a potential future crisis.
The information and content contained in this blog post are for general informational purposes only, and does not, and is not intended to, constitute legal advice. As always, for specific questions concerning your 401(k) retirement plan, or for help in operating and/or amending your plan in response to the CARES Act provisions, please consult your own ERISA attorney or advisor.