Six months after its passage on March 27, the Coronavirus Aid, Relief and Economic Security Act continues to impact employer-sponsored 401(k) plans. Enacted at the height of the COVID-19 pandemic, the CARES Act allowed employers to offer participants greater access to their retirement savings through increased distribution rights and loan limits.
However, with all that has happened since its passage in the spring, it can be easy for an employer to forget about the CARES Act and how its changes continue to impact participants. As year-end approaches, employers should take the following issues into consideration.
For distributions from Jan. 1 through Dec. 30, a plan is permitted, but not required, to allow qualified individuals to treat a 401(k) plan distribution as a coronavirus-related distribution, or CRD. Treatment as a CRD has a number of benefits, including the distribution not being subject to the 10% early withdrawal tax for distributions prior to age 59.5 and being taxed pro rata over a three-year period (2020-2022), unless the individual elects otherwise. Up to $100,000 could be taken by the individual through one or more CRDs.
Many employers initially jumped at the opportunity to offer CRDs to qualified individuals. A "qualified individual" under the CARES Act was initially defined as an individual:
- Who is diagnosed with COVID-19;
- Whose spouse or dependent is so diagnosed; or
- Who experiences adverse financial consequences as a result of being quarantined; being furloughed or laid off or having work hours reduced due to such virus; being unable to work due to a lack of child care because of the virus; closing or reducing hours of a business owned or operated by the individual due to the virus; or such other factors determined by the Internal Revenue Service.
After employers struggled with the meaning of "adverse financial consequences" for purposes of determining who is a qualified individual and whether it was limited solely to the participant, the IRS expanded the definition in Notice 2020-50 to include:
- Participants (and beneficiaries), their spouses or dependents diagnosed with COVID-19; or
- Participants (or beneficiaries), or their spouse or a member of their household, who experience adverse financial consequences as a result of a number of enumerated events — including quarantine, furloughs, layoffs, rescinded or delayed job offers, reduction in work hours or pay, inability to work due to lack of child care, and closing or reducing hours of a business owned or operated by such individual.
Many employers have seen a run on 401(k) account balances under the CRD provisions of the CARES Act, in part because of the ability to self-certify one's eligibility. An individual's designation as a qualified individual under the CARES Act only needs to be certified by the individual seeking the distribution. There is no duty on the employer to inquire whether an individual has in fact satisfied the conditions. As a result, some employers that initially offered CRDs are now questioning that decision.
Employers that elected to permit CRDs have the ability to revoke that election prospectively. Any employer that does so should distribute a carefully worded statement to eligible employees making them aware of the fact that CRDs will no longer be available going forward, but that prior CRDs remain subject to the favorable tax treatment under the CARES Act.
The opposite is also true. An employer that chose not to allow CRDs upon the passage of the CARES Act could elect to do so now. Absent any further extensions to the existing deadline, CRDs may be offered to employees through Dec. 30.
Loan Limit Increase
401(k) plans were also permitted to increase the loan limit from $50,000 and 50% of a participant's account balance to $100,000 and 100% of a participant's account balance. This increase remains an aggregate limit taking into account other outstanding loan balances. The increased limit was available for loans made from March 27 through Sept. 22.
An employer that chose to increase the loan limit under the CARES Act should ensure that the existing limits under Section 72(p) of the Internal Revenue Code are reinstated with respect to any loans that were made beginning on Sept. 23.
The temporary nature of the CARES Act provision has expired and any new loans should not be treated as subject to that increased limit. A communication to employees informing them of this return back to the normal loan limits may be prudent, particularly with respect to a plan that has had a high usage rate for loans under the increased limit.
An employer that did not choose to implement the increased loan limit is no longer able to offer that increased limit to participants.
The CARES Act permitted loan payments due between March 27 and Dec. 31 to be suspended for a year. IRS Notice 2020-50 established a safe harbor for employers who choose to offer these suspensions for qualified individuals.
The loan repayment suspension is available with respect to a loan that is outstanding on or after March 27, with a payment due date that occurs during the period beginning on March 27 and ending on Dec. 31. Loan repayments are to resume after the end of the suspension period — no later than Jan. 1, 2021 — and the term of the loan may be extended by up to one year from the date the loan was originally due to be repaid. Interest accrued during the suspension period must be added to the remaining principal loan balance.
Employers are permitted to offer this loan payment suspension to qualified individuals, however it is up to the individual participant to determine whether such a suspension makes sense with respect to their outstanding loan. Employers that elect to offer this suspension opportunity to participants should ensure that all participants with affected loans are made aware of the suspension option.
For many employers, the 401(k) provisions of the CARES Act were "out of sight, out of mind" after choosing to implement some or all of its permissible changes. However, as detailed above, employers should continue to monitor these changes through the end of 2020 to ensure that 401(k) plans remain in compliance with the requirements of the CARES Act.
In addition, employers that may wish to change an election that they previously made under the CARES Act should ensure that any such change is compliant with the terms of the 401(k) plan and the requirements of the Internal Revenue Code.
Timothy B. Collins is a partner at Duane Morris LLP.
Reprinted with permission of Law360.