Plan sponsors looking to assist participants struggling to deal with the impact of COVID-19 were provided with two new tools in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) passed on Friday, March 27. These options are available now, even without the need to immediately adopt authorizing plan amendments. Even plans that do not currently authorize participant loans or in-service distributions will be able to use these tools and adopt plan amendments by the end of the first plan year beginning on or after January 1, 2022. These provisions are similar to those contained in previous disaster relief legislation.
In addition, required minimum distributions from defined contribution plans, including 403(b) plans and 457 plans of governmental entities, as well as required minimum distributions from IRAs, are suspended in 2020. The suspension of these required minimum distributions will protect older individuals from incurring losses when plan assets are sold to fund the distributions.
Here is how the loan and distribution rules work:
Tax Break on Distributions up to $100,000
401(k) plans may make distributions of up to $100,000 to eligible participants, including those who are still working or on leave, regardless of the regular qualification rules. Participants are eligible if they, their spouse or a dependent are diagnosed with COVID-19 or if any of these individuals suffer COVID-19-related financial consequences due to quarantine, furlough, layoff, reduction of hours or COVID-19-related inability to work due to lack of childcare or closure of a small business by a business owner.
The $100,000 limit applies to total distributions from all plans of the employer and controlled group members, applying the rules in Section 414 of the Internal Revenue Code.
IRAs are also permitted to make these distributions.
The 10% tax on early distributions is waived for qualifying distributions, there appears to be no mandatory 20% income tax withholding, and federal income tax on the distributions will be spread ratably over three tax years. Qualifying distributions also may be paid back into any plan to which rollover contributions may be made tax-free and without regard to the regular contributions limits.
Plan sponsors may rely on employee certifications that the requirements have been met in determining eligibility for these distributions.
Increase in Maximum Plan Loans
Most 401(k) plans permit plan loans. The Internal Revenue Code limits the loans to the lesser of $50,000 or 50% of the participant’s vested account balance. The CARES Act increases the maximum loan amount for eligible participants as defined above to $100,000 or, if less, the participant’s entire vested account balance for loans made during the 180-day period beginning on enactment.
Payment Relief for Participants with Outstanding Loans
Participants with outstanding loans that have payments due in the period beginning on the effective date of the CARES Act and ending on December 31, 2020, can have their loan repayments delayed for one year. Subsequent repayments will be adjusted to reflect this repayment moratorium, and the delay will not be considered in determining whether the loan term exceeds five years.
Additional Plan Sponsor Relief
Industry groups had requested additional relief for items such as form filings and funding.
It should be noted that recently released IRS Notice 2020-18 provided that the extension to file tax returns to July 15, 2020, also extends automatically the deadline to make IRA and qualified plan contributions for 2019. In addition, the CARES Act extends the deadline for sponsors of single-employer defined benefit plans to make required minimum contributions that are due in 2020 to January 1, 2021. This includes quarterly contributions. The delayed contributions must be adjusted for interest.
The Department of Labor was also given authority to extend deadlines for filings. Although no specific extensions were included in the CARES Act, it is very likely that the Department of Labor will use this authority to extend at least some Form 5500 deadlines.
This new relief may be followed by more changes as Congress grapples with the effects of COVID-19 on the economy. However, the new distribution and loan rules are voluntary, not mandatory. All plan sponsors should consult with their counsel to determine whether and how to implement the optional provisions of CARES Act relief.