Year-End Stimulus Act Effectively Extends Key Cares Act 401(k) Provisions
On December 27, 2020, President Trump signed the Consolidated Appropriations Act of 2021 (the “Stimulus Act”), which includes the much-heralded coronavirus stimulus package that has been the subject of intense negotiations in recent months. For 401(k) plans, the Stimulus Act’s provisions in many ways replace or extend similar provisions that were contained in the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act (see our previous article “Congress Passes CARES Act In Response to COVID-19 Crisis, Contains 401(k) Ease-of-Access and Other Provisions” for details).
KEY TAKEAWAYS: The Stimulus Act, in effect, extends the corresponding CARES Act provisions relating to “coronavirus related distributions” and higher-limit 401(k) plan loans that otherwise had already expired, or were scheduled to expire by year’s end. The new expiration date for each of these features is June 25, 2021. The Act also adds a couple of new provisions that were not part of the CARES Act.
Background. On March 27, 2020, in response to the global COVID-19 pandemic, President Trump signed the CARES Act (see above), which, among other things, contained several provisions intended to grant ease of access to 401(k) plan accounts by plan participants affected by the worldwide health crisis. The major retirement provisions included expanded penalty-free withdrawals from 401(k) plan accounts, an increase in the amount available to be taken in loans from 401(k) plans, and a suspension of required minimum distributions for the 2020 calendar year. The CARES Act provisions were intended to be temporary; for example, the expanded plan loan provisions ended on September 23, 2020, and the penalty-free withdrawal provisions were set to expire on December 31, 2020.
With the pandemic worsening during the course of 2020, pressure mounted on Congress to enact additional stimulus measures. But political disagreements and other circumstances hindered progress on several different relief packages until finally a bipartisan deal passed both houses on December 21, 2020 and was signed into law on December 27th.
Although the bulk of the Stimulus Act focuses on direct payments to individuals, unemployment insurance extensions, small business assistance, a moratorium on evictions, and similar relief, there are also some provisions that affect employee benefit retirement and health and welfare plans. This article is intended solely to highlight the major Stimulus Act provisions that affect 401(k) plans and is not intended as an exhaustive analysis of the Stimulus Act or of 401(k) plan loans, withdrawals, or similar topics.
The Stimulus Act and 401(k) Plans. Generally stated, the Stimulus Act (i) provides that the 10% early withdrawal penalty does not apply to a “qualified disaster distribution”; (ii) effectively extends the CARES Act’s increased limit for 401(k) plan loans made because of a disaster; (iii) enacts special rules for the recontribution of retirement plan distributions intended to be used for a home purchase in a qualified disaster area; and (iv) adds a special provision regarding partial 401(k) plan terminations. A general overview of each of these provisions follows:
401(k) Plan “Qualified Disaster Distributions.” Absent certain exceptions (such as distributions or withdrawals made due to “hardship”), a 10% early distribution penalty applies to distributions from an employer retirement plan (such as a 401(k) plan) to employees who are under the age of 59 ½. (See “401(k) Plan Distributions and Vesting” for a general discussion.) The CARES Act added a new, temporary exception to this rule for “coronavirus-related distributions.” The Stimulus Act effectively extends the CARES Act provision, although it uses different terminology.
The Stimulus Act provides that the 10 percent early withdrawal penalty does not apply to any “qualified disaster distribution,” which is defined as any distribution made from an eligible retirement plan (including a 401(k) plan) on or after the first day of the occurrence of a “qualified disaster” prior to June 25, 2021. To qualify, the individual’s principal place of abode during the incident period must be located in a “qualified disaster area,” and the individual must have sustained an economic loss by virtue of the disaster.
OBSERVATION: As of this date, all fifty states and the District of Columbia have been designated as “qualified disaster areas” due to the pandemic, and the pandemic itself meets the statutory definition of “qualified disaster” by virtue of having been declared such pursuant to federal law. Accordingly, the Stimulus Act qualification criteria for “qualified disaster distributions” effectively align with those for “coronavirus-related distributions” under the CARES Act.
Echoing the prior rule, the aggregate amount of distributions that may be treated as “qualified disaster distributions” for any tax year generally may not exceed $100,000.
OBSERVATION: It appears that this total would include the amount of any “coronavirus-related distributions” that were previously taken out under the CARES Act. So, for example, if a participant took $60,000 earlier in 2020 as a “coronavirus-related distribution,” he or she should only be able to take up to $40,000 during the same tax year as a “qualified disaster distribution” under the Stimulus Act.
Also mirroring the similar CARES Act rule, qualified disaster distributions are generally taxed ratably over the three-tax year period beginning with the year in which the distributions are taken. However, taxpayers may elect to not have this three-tax year rule apply, instead choosing to pay all of the income tax in the year of distribution.
401(k) Plan Loans Made Pursuant to a Disaster. ERISA and the Internal Revenue Code permit participants in 401(k) plans to borrow against their plan account balances in certain circumstances. (See our article “401(k) Participant Loans and Prohibited Transactions” for details about 401(k) plan loans.) Normally, loans are limited in the aggregate to the lesser of $50,000 or 50 percent of the vested percentage of a participant’s account balance.
The CARES Act temporarily modified the rules regarding 401(k) plan participant loans by doubling both the previously existing dollar limit ($100,000, up from the regular $50,000), and the percentage limit (100 percent of a participant’s account balance, up from the regular 50 percent), in the case of loans made to “qualified” individuals affected by the global pandemic. The increased limits were originally effective for plan loans made beginning on March 27, 2020, and ended on September 23, 2020.
The Stimulus Act provides that, in the case of any loan from a qualified employer plan (including a 401(k) plan) to a “qualified individual” (see below) made during the 180-day period beginning on December 27, 2020 and ending on June 25, 2021, (i) $100,000 is substituted for the regular $50,000, and (ii) “the present value of the nonforfeitable accrued benefit of the employee under the plan” is substituted for “one-half of the present value of the nonforfeitable accrued benefit of the employee under the plan” (in other words, 100 percent is substituted for 50 percent).
OBSERVATION: The Act effectively extends the former CARES Act provision regarding expanded, higher limit 401(k) loans for 180 days measured from the date of enactment (December 27, 2020); in other words, through June 25, 2021.
“Qualified Individual” Defined. A “qualified individual” means any individual (i) whose principal place of abode at any time during the” incident period” of any qualified disaster is located in the qualified disaster area relating to such qualified disaster (see above discussion on “disaster related distributions” for information on what constitutes a “qualified disaster”); and (ii) who has sustained an economic loss by reason of such qualified disaster. (“Incident period” simply means the period specified by FEMA as the period during which the disaster – for example, the COVID-19 pandemic – occurred, or continues to occur.)
Repayments. Echoing the similar, former CARES Act provisions, for plan loan repayments that are due between the first day of the incident period of a qualified disaster and 180 days following the last day of such incident period, the Stimulus 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 repayment (including any interest accruing during that delay). The one-year delay is disregarded for purposes of the generally applicable five-year limit on loan repayments.
Recontributions of 401(k) Plan Distributions Used for Home Purchases in Qualified Disaster Areas. A Stimulus Act provision that was not part of the CARES Act provides that any individual who received a “qualified distribution” (see below) from a 401(k) plan may, during the “applicable period” (as defined below), make one or more contributions, in an amount not to exceed the amount of the distribution, to an eligible retirement plan that accepts rollovers.
Solely for these purposes, a “qualified distribution” means a distribution from a 401(k) plan intended to purchase or construct a principal residence in a “qualified disaster area,” but which was not actually used for this purpose, due to the occurrence of a “qualified disaster.” Allowing participants to roll the amount of money back into a 401(k) plan or IRA permits participants to “undo” the distribution and avoid taxation and loss of retirement savings due to an unavoidable circumstance.
COMMENT: Although the occurrence of the “qualified disaster” was most likely intended to be related to the COVID-19 pandemic, the law is not written so narrowly. Strictly speaking, use of the term “qualified disaster” here and elsewhere in the Stimulus Act suggests that the provision might extend to any occurrence declared by FEMA to be a major disaster.
The qualified distribution must have been received during the period beginning on the date which is 180 days before the first day of the “incident period” (as defined in above discussion on “disaster related distributions”) of such qualified disaster, and ending on the date which is 30 days after the last day of such incident period.
The term “applicable period” means, in the case of a principal residence in a qualified disaster area with respect to any qualified disaster, the period beginning on the first day of the incident period of the qualified disaster and ending on June 25, 2021.
Temporary Partial Plan Termination Provisions. In another provision that was not included in the CARES Act, the Stimulus Act provides that a 401(k) plan will not be treated as having experienced a “partial termination” during any plan year which includes the period beginning on March 13, 2020 and ending on March 31, 2021, if the number of active participants in the plan on March 31, 2021 is at least 80 percent of the number of active participants that were covered on March 13, 2020.
- The Stimulus Act rules regarding disaster related distributions are effective for distributions made from now through June 25, 2021.
- The rules regarding extended 401(k) plan loans are effective for loans taken from between December 27, 2020 and June 25, 2021.
- The rules regarding recontributions of 401(k) plan distributions used for home purchases are effective on and after December 27, 2020 and ending on June 25, 2021.
- The new rule regarding partial plan terminations is effective on and after December 27, 2020 and applies solely to events occurring within the time period previously described (i.e., March 13, 2020 through March 31, 2021).
Plan Amendments. In general, 401(k) plans will need to be amended to reflect the Stimulus Act provisions, but the deadline for amendment is generally extended until the last day of the plan year beginning on or after January 1, 2022 (i.e., December 31, 2022, for calendar year plans).
Footnote: A Matter of Policy – Retirement Money, or Not? (This footnote originally appeared in our blog “Congress Passes CARES Act In Response to COVID-19 Crisis, Contains 401(k) Ease-of-Access and Other Provisions“)
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 your plan during the current COVID-19 crisis, please consult your own ERISA attorney or professional advisor.