The Coronavirus Aid, Relief, and Economic Security Act, or the “CARES Act,” enacted on March 27, 2020, includes provisions to provide financial relief to participants in eligible retirement plans. A general overview follows.
With some exceptions, an additional 10% early distribution tax is imposed by the Internal Revenue Code on distributions made to an individual before age 59½ from an eligible retirement plan, including such plans as 401(k) plans, profit sharing plans, and individual retirement accounts.
The Act allows individuals in eligible retirement plans to receive a coronavirus-related distribution of up to $100,000 without incurring the 10% early distribution tax. To qualify as a coronavirus-related distribution, the distribution must be made in 2020 to a “qualified individual.” A qualified individual includes:
- An individual who has been diagnosed with the virus by a CDC approved test or whose spouse or dependent has been diagnosed with the virus by a CDC approved test.
- An individual who experiences adverse financial consequences resulting from a reduction in work hours or being laid off, furloughed, quarantined, or unable to work due to the lack of childcare because of the virus.
- An individual who experiences adverse financial consequences resulting from a closing or reducing the hours of a business owned or operated by the individual because of the virus.
The Act provides that the IRS may prescribe other factors to be used to determine if an individual who experiences adverse financial consequences on account of the virus is a qualified individual.
A coronavirus-related distribution is not treated as an eligible rollover distribution. It cannot be rolled over tax-free to another eligible retirement plan and would not be subject to mandatory 20% federal income tax withholding.
A coronavirus-related distribution is included in a qualified individual’s taxable income ratably over a three-year period, unless the qualified individual elects otherwise for a taxable year.
The Act allows a qualified individual who receives a coronavirus-related distribution to repay the distribution to an eligible retirement plan that permits rollover contributions. Repayment may be made in one or more payments over the three-year period following receipt of the coronavirus-related distribution. Any such repayment would be treated as a rollover contribution.
There are many questions. Guidance will be necessary on what actions, if any, a plan must take to implement and administer a coronavirus-related distribution. It is not clear if this is intended to be a new distribution type that plans may adopt or another exemption to the application of the 10% early distribution tax not requiring adoption by a plan. Guidance will also be necessary on the application of the income tax and rollover provisions. One item of particular note is that the coronavirus-related distribution provisions apply to distributions made on or after January 1, 2020. This presumably means that individuals who received a distribution before the enactment of the Act may be able to treat that distribution as a coronavirus-related distribution if a qualified individual and the requirements are otherwise met.
The Act relaxes some of the Internal Revenue Code limits and requirements for loans made to a qualified individual from a qualified plan. A qualified individual for this purpose is the same as a qualified individual who can receive a coronavirus-related distribution.
The Internal Revenue Code generally limits the amount of a loan made to a participant from a qualified plan to the lower of:
- $50,000; or
- 50% of the value of the participant’s account (or $10,000 if greater).
For loans made to qualified individuals during the 180-day period following the March 27, 2020 enactment of the Act, the Act increases the loan limit to the greater of $100,000 or 100% of the value of the participant’s account.
The Internal Revenue Code requires that loans not used to acquire a principal residence be repaid over five years in substantially level payments made at least quarterly. The Act temporarily relaxes the repayment terms for qualified individuals with loans outstanding on or after the March 27, 2020 enactment of the Act:
- If the due date for a repayment occurs during the period beginning on March 27, 2020 and ending on December 31, 2020, the due date is delayed for one year.
- The subsequent loan repayments must be appropriately adjusted to reflect the delay in the due date and any interest that may accrue during the delay.
- The one-year delay period is disregarded in applying the five-year repayment term and level amortization requirements.
It appears that this provision is optional, but there is no current consensus on this. Implementation of the provision would require coordination with recordkeepers and service providers and a review of loan documentation.
Required Minimum Distributions
Generally, tax qualified plans and individual retirement accounts must pay a required minimum distribution (“RMD”) in 2020 to participants who attained age 70½ before 2020 and to beneficiaries following a participant’s death.
The Act waives the RMD due for 2020 from a defined contribution plan or IRA. This includes the RMD due to a participant who attained age 70½ in 2019 and who had not received the 2019 RMD in 2019. This will provide financial relief to participants and beneficiaries who would have to receive an RMD based on 2019 year-end values from a defined contribution plan account or IRA impacted by recent market declines. This waiver is not limited to qualified individuals.
A plan must offer a direct rollover/payment election to a participant eligible to receive an eligible rollover distribution. If paid directly to a participant, an eligible rollover distribution is subject to mandatory 20% federal income tax withholding. The Act provides that any amount of a waived 2020 RMD distributed in 2020 will not be treated as an eligible rollover distribution for these purposes. This means a plan does not have to offer a direct rollover/payment election for a waived 2020 RMD and the distribution of a waived 2020 RMD will not be subject to mandatory 20% federal income tax withholding. It appears though that a recipient of a waived 2020 RMD will be able to make a tax-free rollover of the distribution to an eligible retirement plan (including an IRA) after its distribution.
Following a participant’s or IRA owner’s death, RMDs for the beneficiary may be determined under a 5‑year rule or 10‑year rule (depending upon the application of the SECURE Act enacted on December 20, 2019). Under the 5‑year rule, a participant’s account balance or IRA balance is required to be distributed by the end of the calendar year in which falls the fifth anniversary of the participant’s death. Under the 10‑year rule, a participant’s account balance or IRA balance is required to be distributed by the end of the calendar year in which falls the tenth anniversary of the participant’s death. Under the Act, these periods are determined without regard to 2020. This means if 2020 would otherwise be included in the 5‑year or 10‑year period, the period ends one year later than it normally would.
The Worker, Retiree, and Employer Recovery Act of 2008 enacted after the financial crisis of 2008 similarly waived RMDs due for 2009. The IRS issued a notice to provide guidance on the 2009 RMD waiver. It is expected that the IRS will issue similar guidance for the 2020 RMD waiver.
To the extent amendments are required with respect to the coronavirus-related distribution, plan loan and RMD waiver provisions, plan sponsors will have until the last day of the first plan year beginning on or after January 1, 2022 to amend their plans. (Governmental plans have an extra two years for any required amendments.) The extended amendment deadline applies only if the plan is operated in accordance with the change(s) made from and after its effective date.
Single-Employer Defined Benefit Pension Plan Funding Relief
The Act also provides financial relief to employers that maintain single-employer defined benefit pension plans.
The Act delays any minimum required contributions that would otherwise be due to a single-employer defined benefit pension plan during 2020 (including quarterly contributions) to January 1, 2021. The amount of the minimum required contribution will be increased by interest from the original due date to the payment date.
The Internal Revenue Code imposes benefit and payment limitations on a single‑employer defined benefit pension plan based on the plan’s adjusted funding target attainment percentage (“AFTAP”). A plan sponsor may elect to treat the plan’s AFTAP for the last plan year ending before January 1, 2020 as the AFTAP for plan years that include 2020. This may help the pension plan from becoming subject to the funding-based benefit and payment limitations for the plan year that includes 2020.
Should you have any questions on the CARES Act and your retirement plans, please contact Rich Kennedy, any member of the Multiemployer Plans and Employee Benefits Group, or any other Meyer, Unkovic & Scott attorney with whom you have worked.
Meyer, Unkovic & Scott COVID-19 Legal Resource Center
For updates on this and other legal matters associated with COVID-19, please visit our Coronavirus Legal Resource Center at: https://www.muslaw.com/coronavirus-covid-19-resource-page/.
This material is for informational purposes only. It is not and should not be solely relied on as legal advice in dealing with any specific situation.