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Accessing Retirement Plan Funds Under CARES Act and Existing Law Accessing Retirement Plan Funds Under CARES Act and Existing Law

Accessing Retirement Plan Funds Under CARES Act and Existing Law

This publication provides an overview of the frequently asked questions (FAQs) we have received from clients who want to provide employees with increased access to their retirement funds in light of personal financial challenges caused by the coronavirus outbreak (now known as COVID-19). We address options to reduce or suspend elective deferrals and liberalize distribution and loan options to plan participants under existing law as well as under the Coronavirus Aid, Relief and Economic Security Act of 2020 ("CARES Act"), which passed the House today, March 27, 2020, and is expected to be signed by the President.

It is particularly important for plan sponsors to understand how the new distribution provisions under the CARES Act impact their retirement plans since at least some retirement plan recordkeepers are requiring immediate decisions as to whether or not to permit these distributions. 

Question: Our retirement plan currently restricts most or all distributions until an employee terminates employment. What options can we consider to permit in-service distributions to employees while they are still working?

Plan sponsors of 401(a) profit sharing and money purchase pension plans, 401(k) plans, qualified defined benefit plans, 403(b) plans, and governmental 457(b) plans may permit employees who are still working to take a distribution of their account at age 59½ for any reason. Tax-exempt employers that sponsor 457(b) plans may also permit in-service distribution to employees beginning at age 70½.

In addition to in-service distributions after attaining a specified age, defined contribution plans may allow in-service distributions for certain specified reasons:
  • on account of a financial hardship or an unforeseeable emergency (see next question);
  • disability (without a severance from employment); or
  • a qualified birth and adoption.
Additionally, if the plan accepts rollover contributions from other retirement plans or IRAs, the plan may permit a distribution of those funds at any time, without restriction.

Title II, Subtitle B, Section 2202(a) of the CARES Act adds a new category of in-service distribution, referred to as a "coronavirus-related distribution," available to qualified individuals regardless of whether the distribution would otherwise be permitted under applicable law. A coronavirus-related distribution is a distribution of up to $100,000 for a taxable year made from a 401(a) plan, 403(b) plan, governmental 457(b) plan, or IRA on or after January 1, 2020, and before December 31, 2020, to a qualified individual. A "qualified individual" is an individual who:
  • is diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention, or
  • has a spouse or dependent diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention, or
  • experiences adverse financial consequences as a result of (i) being quarantined, furloughed or laid off or having work hours reduced due to COVID-19, (ii) being unable to work due to lack of child care due to COVID-19, (iii) being unable to work due to closing or reducing hours of a business owned or operated by the individual due to COVID-19, or (iv) other factors as determined by the Secretary of the Treasury.
Importantly, the plan administrator may rely on an employee's certification that one of the above conditions is satisfied in determining whether a distribution is a coronavirus-related distribution. Moreover, an employer is responsible for ensuring compliance with the $100,000 limit only with respect to the retirement plans it and any employer in its controlled group maintains. 

A coronavirus-related distribution is not treated as an eligible rollover distribution, mandatory withholding does not apply, and a 402(f) special tax notice is not required. Accordingly, 10% withholding will apply, unless the participant elects out of withholding.  

Unless a participant elects otherwise, a coronavirus-related distribution will be included in the participant's gross income ratably over three tax years beginning with the year of distribution. A participant who receives a coronavirus-related distribution may repay the distribution in one or more contributions to any eligible retirement plan to which a rollover contribution can be made within three years of the distribution. The repayment will be treated for tax purposes as a direct rollover (or, if made to an IRA, as a trustee-to-trustee transfer) made within 60 days of distribution.

This new distribution category appears to be an optional plan provision.

Regardless of whether or not a retirement plan is amended to permit coronavirus-related distributions, the 10% early distribution penalty tax will not apply to a distribution that otherwise qualifies as a coronavirus-related distribution. For example, assume a participant is laid off at age 45 due to COVID-19 and takes a $10,000 distribution from the retirement plan due to his severance from employment. Normally, he would have to pay a 10% early distribution penalty tax on the distribution. Under the CARES Act, however, even though the distribution is taken due to the participant's severance from employment, since it meets the definition of a coronavirus-related distribution, the distribution will be exempt from the 10% early distribution penalty tax. The same result will hold true for a distribution made under a retirement plan's hardship withdrawal provisions to a qualified individual.
Impact on Plan: To the extent a retirement plan's distribution provisions are more restrictive than what the Code requires, the plan sponsor could consider amending the plan to allow active participants the opportunity to take in-service distributions that are permitted by law. Of course, a plan sponsor would need to balance employee need for extra income against the possibility of retirement leakage, i.e., that employees who take distributions too early may not be adequately prepared for retirement. In any event, however, plan sponsors should be prepared to properly report distributions, otherwise available, which satisfy the requirements of a "coronavirus-related distribution."

Question: Are expenses related to the COVID-19 public health emergency eligible for financial hardship distributions or unforeseeable financial emergency distributions?

Certain expenses related to COVID-19 may be eligible for a hardship distribution or unforeseeable financial emergency distribution. Plan sponsors of 401(k) and 403(b) plans that allow hardship withdrawals under the safe harbor rules can already permit distributions for medical expenses and funeral expenses incurred by the participant and his or her family members related to COVID-19. In addition, a hardship withdrawal can be taken if a lack of income due to a layoff leads to a foreclosure or eviction. Moreover, the Bipartisan Budget Relief Act of 2018 expanded the list of reasons for a hardship withdrawal under the safe harbor rules to include losses incurred by participants who work or reside in an area designated by the Federal Emergency Management Agency ("FEMA") as a major disaster area eligible for individual assistance. FEMA has declared several states (such as New York, Illinois, New Jersey, Texas, Florida, California, Washington State, and Louisiana) to be major disaster areas eligible for individual assistance due to the COVID-19 pandemic. This declaration, among other things, enables plan participants residing or working in these states to take a hardship distribution for losses and expenses, including loss of income, related to COVID-19. It is possible that more states will be subject to such declarations going forward. 

Impact on Plan: Plan sponsors could consider amending their retirement plan(s) to expand the allowable reasons for a hardship distribution outside of the safe harbor rules to cover additional expenses related to COVID-19. For tax-exempt and governmental 457(b) plans, plan sponsors can consider whether medical and other expenses related to COVID-19 qualify under the plan's unforeseeable emergency provisions.

Question: Our retirement plan permits loans. Can we loosen restrictions on the loans available under our plan?

Plan loans must meet the requirements of Code Section 72(p). Very generally, these rules limit the amount a participant may borrow relative to the participant's total account balance, limit the term of the loan to five years except for home loans, and require level repayments. 

By policy, many plan sponsors impose additional requirements and constraints on plan loans. For example, an employer may choose to limit plan loans to employee contributions only (with no access to employer contributions) and may permit only one or two outstanding loans at a time. A restriction on the number of loans to one or two could prevent an employee who is currently repaying a loan from borrowing additional amounts, even if the amount of the outstanding loan is well below the limit under Code Section 72(p).

Although plan loans must be repaid to the plan within statutory time frames to avoid unfavorable tax results, plan sponsors may allow cure periods for late loan repayments. The maximum cure period allowed under law for a missed payment can be as late as the last day of the calendar quarter ending after the calendar quarter in which the loan repayment is missed. However, plan sponsors may by policy or plan design be more restrictive and require loan repayments to be made in shorter time frames.

A plan can provide for the suspension of loans for up to one year during a leave of absence that is either unpaid or paid at a rate less than the loan repayment amount. A suspension does not extend the term of the loan or change the amount of the required repayments. Again, however, plan sponsors may, by policy or plan design, instead provide that loans are not suspended during leaves of absence generally or during leaves of absence other than military leaves. 

Title II, Subtitle B, Section 2202(b) of the CARES Act increases the loan limits for any loan made from a 401(a), 403(b) or governmental 457(b) plan to a qualified individual during the 180 day period beginning on the date of enactment of the Act. The Act increases the maximum loan amount to $100,000 (currently $50,000) and permits loans up to the greater of $10,000 or 100% (currently 50%) of the present value of the participant's account.

The CARES Act also extends the due date for a qualified individual with an outstanding loan (on or after the date of enactment of the Act) under a retirement plan. If the due date for any loan repayment occurs during the period from enactment of the Act through December 31, 2020, the due date for the repayment is delayed one year. Any subsequent repayments of the loan are required to be adjusted to reflect the delayed due date and any interest accruing during such delay, and the delay is disregarded for purposes of determining compliance with the five year term limit.

Only "qualified individuals" are eligible for this loan relief. The term qualified individual has the same meaning as described above for a coronavirus-related distribution. However, unlike with respect to coronavirus-related distributions, there is no provision in the loan rule changes that allow the plan administrator to rely on an employee's certification that he or she is a qualified individual.

The loan rule change that temporarily increases the amount of available loans appears to be optional. However, the loan rule change that extends the repayment date of an outstanding loan appears to be required.
Impact on Plan: Plan sponsors that do not currently permit loans could consider amending their plans to allow them. Plan sponsors that already permit loans may wish to review their loan policies to determine if they can allow more flexibility by permitting loans from additional money sources, permitting more than one outstanding loan at a time, permitting longer cure periods for missed loan repayments, suspending loan repayments during unpaid leaves of absence, or temporarily increasing loan limits. Of course, any such changes should be balanced against other goals of the employer. These may include reducing retirement plan leakage, since some employees are likely to default on their loan repayments, and also reducing compliance risk, since loans are consistently found to be a significant area of non-compliance on audit. 

Question: Account balances on December 31, 2019, were generally much larger than they are today. Will required minimum distributions calculated on the December 31 balances be required in 2020?

Required minimum distributions ("RMDs") from defined contribution plans are calculated based on December 31 account balances. Accordingly, a participant may be required to take a disproportionately high RMD for 2020, if his or her December 31, 2019, account balance has significantly declined in value since that date. In 2009, Congress waived RMDs under the Worker, Retiree and Employer Recovery Act of 2009 ("WRERA") for this reason.

Effective January 1, 2020, Title II, Subtitle B, Section 2203 of the CARES Act waives RMDs for defined contribution 401(a) plans, 403(b) plans, governmental 457(b) plans, and IRAs for calendar year 2020. The waiver applies to any RMD required to be paid in 2020 and to 2019 RMDs that are required to be made by April 1, 2020 (if not already made in 2019).  For purposes of determining RMDs after 2020, an individual's required beginning date is determined without regard to this 2020 waiver.

In addition, the five year distribution period that applies to certain beneficiaries will be determined without regard to calendar year 2020. 

If an eligible rollover distribution paid in 2020 would have been a RMD for 2020 but for the waiver, the distribution is not subject to the direct rollover rules, 20% mandatory withholding requirement, or the 402(f) notice. Accordingly, 10% withholding will apply, unless the participant elects out of withholding.

Question: What can we communicate to employees regarding their ability to modify or suspend salary contributions to our retirement plan?

Plan sponsors of 401(k) plans and 403(b) plans may permit active participants to modify or terminate an election to make elective deferrals (both pre-tax and Roth) to the plan at any time. This applies to voluntary elective deferrals only, not to mandatory employee contributions which are required as a condition of employment or pursuant to law. An election change may be effective as soon as administratively feasible after the participant submits a completed and signed salary reduction form that reflects the change or termination, and it will apply to compensation that has not yet been paid. Some employers may permit such changes electronically, which can expedite election changes so they can be implemented more quickly.

Plan sponsors of tax-exempt or governmental 457(b) plans may also permit active participants to change or terminate elective deferrals. Under the rules for 457(b) plans, any change or termination of an existing election will not be effective before the first day of the month following the month the change or termination occurs. For example, a new salary reduction form received by the plan in March will be effective with respect to the first pay in April, but if the form is not received by the plan until April, then any change or termination will not take effect until the first pay in May.

Plan sponsors that impose administrative restrictions on a participant's ability to make election changes (e.g., if the plan only permits election changes on a quarterly basis) may consider relaxing those restrictions to permit employees an opportunity to reduce or terminate their deferrals as early as permitted by law to address current cash flow needs. This will allow employees to increase their take home pay now and re-start elective deferrals later in the year should their circumstances permit.   

Question: How long does a plan sponsor have to amend its plan document to adopt the changes permitted under the CARES Act or make other permitted changes?

Discretionary amendments to retirement plans must generally be made by the last day of the plan year in which the change is effective. For example, if a plan sponsor wants to add loans to its retirement plan effective April 1, 2020, the plan will need to be amended by no later than December 31, 2020, to permit that change.

There is a special amendment period for changes under the CARES Act. If a plan sponsor wants to amend its retirement plan to take advantage of changes permitted under the CARES Act, then the plan must be amended for such changes by the last day of the first plan year beginning on or after January 1, 2022 (January 1, 2024 for governmental plans). For a calendar year plan, the deadline would be December 31, 2022 (December 31, 2024, for governmental plans). For a plan with a July 1 fiscal year plan, the deadline would be June 30, 2023 (June 30, 2025, for governmental plans).
To discuss these issues and any other issues related to your retirement or employee benefit plans, please contact Gary Blachman, Audra Ferguson-Allen, Sarah Funke, Robert L. Gauss, Melissa Proffitt, Kathleen Sheil-Scheidt, Shalina Schaefer, Tara S. Sciscoe, and Christopher Sears, or the Ice Miller Employee Benefits attorney with whom you most closely work.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.
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