COVID-19 Update: Unsaving for Retirement in Pandemic Times

Posted by Maria T. Hurd, CPA, RPA

Every year, retirement plan audit season starts in early April, shortly after discrimination tests are complete and audit packages for the more straightforward plans become available. Human resources managers, payroll managers, and chief financial officers at the plan sponsor collaborate to provide the auditor with payroll, personnel data, and financial backup needed for the audit. This year, these plan officials are otherwise occupied, and preoccupied, with furloughs, layoffs, Payroll Protection Program applications, and cash-flow shortages. Cash-flow and personnel concerns also have retirement plan implications, both at the individual and the plan sponsor level. Individuals need cash to pay their bills, even if it means taking a premature distribution or a loan from their retirement plans. Employers need to know whether they can suspend employer contributions to the plan. This blog discusses the access to retirement account funds available to individuals under the CARES Act.

Temporarily Unsaving for Retirement

Philosophically, legislation tries to encourage retirement savings to promote retirement readiness by discouraging leakage of funds from plans, but the Coronavirus pandemic has temporarily changed that. In response to the economic slowdown caused by social distancing mandates, the CARES Act provides new opportunities for individuals to access retirement funds, and to repay the plan after this all blows over.

Coronavirus Distributions

Plan sponsors may, but need not, offer Coronavirus-related distributions up to $100,000. This new distribution is not subject to the 10% penalty on early withdrawals. Many bundled plan document providers are making Coronavirus-related distributions available unless the plan sponsor opts out. These new distributions are available through December 30, 2020 to a plan participant who self-certifies that he or she:

(i) has been diagnosed with COVID-19 by a CDC-approved test,

(ii) has a spouse or dependent diagnosed with COVID-19 by a CDC-approved test,

(iii) has experienced adverse financial consequences because of

a. quarantine

b. furlough

c. layoff

d. hour reduction

e. pay reduction

f. inability to work due to child-care closures

g. business owner whose business is forced to close

Although the 10% penalty typically assessed on early withdrawals does not apply, the income tax on the distribution does, but the tax liability can be spread over a three-year period, if the participant does not recontribute the amount to the plan within three years after its receipt. Since the repayment amount and timing might not coincide with the taxation of the distribution evenly over three years, participants can amend their individual tax returns when repayments take place after the tax has been paid in a prior year. Coronavirus distributions are only subject to voluntary 10% withholding. The tax benefits are available for all distributions that meet the criteria above at the individual taxation level, even if the plan does not adopt the Coronavirus distribution provisions.

Other in-service distributions that are likely already available under the plan provisions, but that would likely be subject to the 10% early distribution penalty include:

  • rollover accounts without restriction,
  • terminating or disability distributions
  • hardship distributions. A tax-law rule’s safe-harbor definition includes several situations that have become prevalent, such as medical expenses, eviction, funeral expenses, tuition, and a participant’s expenses and losses (including loss of income) from a disaster declared by the Federal Emergency Management Agency if the participant’s principal residence or principal place of employment at the time of the disaster was in an area by FEMA designated for individual assistance.
  • Distributions after age 59½ are not subject to the 10% penalty

Withdrawals from a plan in Coronavirus times will likely require realizing losses in a down market if the participant is forced to sell investments to complete the distribution. The same is the case if the participant takes a loan out of the plan, an opportunity that has also been enhanced.

Increased Participant Loan Limits

One of the principal reasons typically given to discourage participant loans is that the participants will forego higher market appreciation than the loan interest rate they pay themselves. One would hope that the market has nowhere to go but up during upcoming five-year loan repayment periods, so the disincentive remains, but participants might not have access to any other funding sources.

The CARES Act grants plan sponsors the opportunity to amend their plans to increase the loan limits and delay repayment for qualified individuals, as defined previously, for loans issued between March 27, 2020 and September 23, 2020.

The higher loan limit is 100% of the qualified participant’s vested balance up to $100,000, up from the traditionally applicable limit of 50% of the participant’s vested balance when the loan is issued up to $50,000. Loan repayments can be delayed for up to one year and the delay period is not included in the five-year maximum repayment period.

Repayments for Existing Loans

The CARES Act permits loan repayments for qualified participants who have existing loans to be delayed for one year. The one-year delay applies to loan repayments due between March 27 and December 31, 2020. A loan will not be deemed to be default on the last day of the quarter following the last repayment date, as they typically would be. Remaining repayments plus interest are reamortized over the extended repayment period.

Until the IRS issues further guidance regarding loan repayments that were due in the last quarter of 2019 or the first quarter of 2020 but were not made, many recordkeepers are delaying tax-reporting a loan as a deemed distribution if the cure period falls between March 27 and December 31, 2020.

If the plan provisions require participant loans to be paid-in-full upon termination of employment, the CARES Act can be invoked in one of two ways. A deemed distribution of the loan balance could be treated as a Coronavirus distribution and not be subject to the 10% penalty nor the 20% mandatory withholding, or the acceleration of the loan could be delayed for a year.

Required Minimum Distributions (RMDs)

The CARES Act allows participants and beneficiaries to forgo taking Required Minimum Distributions that would have been required during 2020. If the required beginning date was in 2019 and the participant intended to take the RMD by April 1, 2020, then that RMD is also eligible to be forgone. The intent is to spare participants from having to lock in investment losses in a substantially down market. A participant who took what otherwise would have been a minimum distribution fewer than 60 days ago might consider his or her opportunity for a rollover into an eligible retirement plan.

Helping Your Employees Unsave for Retirement

I never thought I would write a blog to offer guidance on how to help participants unsave for retirement, but these are unprecedented times. Plan documents do not have to be amended until December 31, 2022 for calendar year plans, but they must be administered in good faith compliance with the new rules. Plan document providers and employee-benefits lawyers can assist with plan documents, and investment advisors, third-party administrators, and recordkeepers must collaborate with employers to update administrative procedures and develop employee communications about Coronavirus withdrawals or loans under the CARES Act. Hopefully, the damage can be quickly undone as the unsaving turns back into saving in upcoming years.