The CARES Act Contains Changes to Retirement Plan Withdrawal Rules – What Are They? [Part I]

Over the past few weeks, the 2019 Novel Coronavirus (or “Coronavirus”) has hit businesses (and employees) financially across the U.S. in an unprecedented fashion. Due to the Coronavirus pandemic, quarantines and shelter in place orders across the country, many businesses have come to a grinding halt and have been forced to furlough or lay off employees.  All this uncertainty has caused individuals to look to other sources to supplement lost income. One such source is their retirement account.  

The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), passed by Congress and signed by President Trump on March 27, offers welcome relief to employees who may need to tap into their retirement accounts, including: 

  • Relief from the 10-percent early withdrawal tax for individuals looking to request an in-service distribution or a hardship withdrawal from their company retirement plan prior to attainment of age 59 1/2; and
  •  For individuals planning to request loans from their employer retirement plan, an increase in the funds available for loan withdrawal, and it also provides for a one-year delay in all loan repayments due through the end of 2020. 

The CARES Act requires that employers who wish to take advantage of these optional expanded rules must amend their retirement plans no later than the end of the 2022 plan year (December 31, 2024 for calendar year government plans).

With the nuances of the existing rules as well as the onslaught of new loan and hardship withdrawal guidance under the CARES Act, company retirement plan decision-makers (i.e., fiduciaries) must be careful to avoid non-compliance pitfalls that could result in costly penalties. The following article provides an overview of existing IRS loan and hardship requirements, updates to loans and hardship withdrawals under the CARES Act, and considerations for employers as they navigate what is likely to be a deluge of retirement plan withdrawal requests in the weeks and months ahead. 

Background

All retirement plans offer some form of account withdrawal where an individual can access his or her money upon the occurrence of a specific event.  Generally, the Internal Revenue Code of 1986, as amended (the “Code”) permits retirement plan distributions upon the following events:

  • Attainment of age 59 ½;
  • Death;
  • Disability; and
  • Termination of employment.

In addition, the Code permits (but does not require) retirement plans to allow for loans and hardship withdrawals.  

Retirement Plan Loans

General Rules Under the Code

A loan option under a tax-qualified retirement plan (e.g., a Code Section 401(k) or 403(b) plan) allows an individual to withdraw a portion of his or her retirement account and ratably repay the loan over a set period.  Under current IRS requirements, repayment of such a loan must occur within five years unless the loan is used to purchase a principal residence. The repayment must also include principal and interest and be made on a pro rata basis at least quarterly. 

If these requirements are met, the loan is not taxable at the time it is taken.  Failure to repay the loan in a timely fashion, however, results in a deemed distribution with ordinary income tax and early withdrawal tax (if the participant is under age 59 1/2) implications. 

Generally, an individual can withdraw a loan under a qualified plan equal to the lesser of:

  • $50,000; or 
  • The greater of $10,000 or one-half of the present value of the participant’s nonforfeitable accrued benefit.   

Changes to Participant Loan Rules under the CARES Act

The CARES Act provides for significant changes to the plan loan rules under Code Section 72(p). First, the CARES Act allows increases the loan amount available for qualified individuals (i.e., those impacted by Coronavirus) the lesser of: 

    • $100,000 (previously $50,000); or
    • The full present value of the participant’s vested accrued benefit (previously he greater of $10,000 or one-half of the present value of the participant’s vested accrued benefit).  

Second, the CARES Act also allows for a one-year delay for all outstanding plan loan repayments for qualified individuals. This extension applies to all repayments due beginning on the date of the enactment of the CARES Act March 27 and through December 31. The CARES Act further provides that all subsequent loan repayments should be appropriately adjusted to reflect the due date and any accrued interest. 

These relaxed loan rules are available for distributions from eligible retirement plans (IRAs, 401(k) plans, 403(b) plans, and 457(b) plans) beginning on the date of CARES Act enactment through December 31, 2020. The expanded distribution rules are generally available for any eligible individual:

  • Who is diagnosed with Coronavirus by a test approved by the Center for Disease Control Prevention; 
  • Whose spouse or dependent (as defined in Code Section 152) is diagnosed with such virus or disease by such a test; or
  • Who experiences adverse financial consequences as a result of Coronavirus due to:
    • Quarantine, layoff, furlough, or having reduced work hours; 
    • Being unable to work due to lack of child care; or
    • Closure or reduction of hours of a business owned or operated by an individual impacted by Coronavirus or other factors as determined by the Department of Treasury.  

Employer Considerations for Participant Loans

For employers with retirement plans that offer loans, important compliance considerations include:

  • With respect to the administration of retirement plan loans, retirement plan fiduciaries must carefully ensure that the loans in operation adherence to the terms of the plan governing loans. In addition to the duties of prudence and loyalty, a retirement plan fiduciary must also operate the plan in accordance with the terms of the plan document (unless a plan provision violates another law).  This also includes any separate loan policies, which are essentially treated as part of the plan. There are IRS non-compliance penalties for failure to administer plan loans in accordance with the plan document that may implicate retirement plan fiduciary issues as well. 
  • Employers who elect to take advantage of the expanded loan and hardship withdrawal provisions provided for under the CARES Act must amend their plan to accommodate these new rules and provide communications (including, for example, a summary of material modifications) to participants that clearly delineate the new criteria for loans.
  • As a best practice, employers who elect to amend their retirement plan to allow for expansion of loan rules under the CARES Act will need to ensure the new limits and requirements are properly applied in operation (including, for example, that no loan amounts to qualified individuals exceed $100,000 in the aggregate)
  • For those non-Coronavirus related loans, employers are still responsible for enforcing loan repayment schedules that include level payments that must be made by the borrowing participants at least quarterly.
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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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