The IRS finally issued much‑needed additional guidance for plan sponsors and recordkeepers on COVID-related distributions and loans from retirement plans and IRAs authorized by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Notice 2020-50 (Notice) supplements the retirement plan FAQs the IRS previously released in May 2020. Read Warner’s eAlert on the retirement plan FAQs here.
Under the FAQs, the IRS stated that the factors taken into account to determine whether an individual is a “Qualified Individual” eligible for a COVID-related distribution or loan were limited to only the adverse financial consequences of the individual, not those of the spouse or dependent, but left open the possibility for the addition of more factors. The Notice expands the factors to add the individual having a reduction in pay or the spouse or a member of the individual’s household (i.e., someone who shares the individual’s principal residence) experiencing adverse financial consequences. A Qualified Individual is now an individual:
- Who is diagnosed with COVID‑19.
- Whose spouse or dependent is diagnosed with COVID‑19.
- Who experiences adverse financial consequences as a result of:
- the individual being quarantined, being furloughed or laid off, or having work hours reduced due to COVID‑19;
- the individual being unable to work due to lack of childcare due to COVID‑19;
- closing or reducing hours of a business owned or operated by the individual due to COVID‑19;
- [new] the individual having a reduction in pay (or self-employment income) due to COVID‑19 or having a job offer rescinded or start date delayed due to COVID‑19;
- [new] the individual’s spouse or a member of the individual’s household being quarantined, being furloughed or laid off, or having work hours reduced due to COVID‑19, having a reduction in pay (or self‑employment income) due to COVID‑19, or having a job offer rescinded or start date delayed due to COVID‑19; or
- [new] closing or reducing hours of a business owned or operated by the individual’s spouse or a member of the individual’s household due to COVID‑19.
The plan administrator may rely on an individual’s certification that the individual satisfies the conditions to be a “Qualified Individual” in determining whether: (1) a distribution is a COVID‑related distribution; (2) the individual qualifies for the special treatment for loans; or (3) the distribution is a COVID-related distribution that may be recontributed to a 401(k) plan, 403(a) plan, 403(b) plan, government sponsored 457(b) plan or IRA (Eligible Plan), unless the plan administrator has “actual knowledge” to the contrary.
Actual knowledge does not mean that the plan administrator is obligated to inquire into whether an individual has satisfied the requirements for being a Qualified Individual. Rather, this requirement is limited to situations in which the plan administrator already possesses sufficiently accurate information to determine the veracity of the certification.
The Notice also includes an example of an acceptable certification. The sample certification lists the Qualified Individual requirements with a statement that the individual meets one of those requirements but does not require the individual to specify which one.
Under the CARES Act, Qualified Individuals receive favorable tax treatment for distributions from Eligible Plans that are COVID-related distributions. Such distributions are not subject to the 10% early distribution tax, are generally includable in income over a three‑year period, and if recontributed to an Eligible Plan within a three-year period, will not be includable in income at all.
Definition of COVID-Related Distribution
A COVID-related distribution is any distribution made from an Eligible Plan on or after January 1, 2020, and before December 31, 2020, to a Qualified Individual up to a maximum of $100,000.
A Qualified Individual may designate a distribution as a COVID-related distribution regardless of whether the Eligible Plan treated the distribution as COVID-related, including the following:
- Periodic payments and distributions received by a Qualified Individual during 2020 that would have been required minimum distributions, if not for the CARES Act required minimum distribution waiver in effect for 2020.
- Any distribution received by a Qualified Individual as a beneficiary.
- A reduction or offset of a Qualified Individual’s account balance to repay a loan.
The Notice clarifies that the following amounts may not be treated as COVID-related distributions:
- Corrective distributions to comply with the Code Section 415 limitations.
- Refunds of excess elective deferrals over the annual deferral limit ($19,500 for 2020).
- Refunds of excess contributions from a 401(k) plan.
- Refunds of excess aggregate matching and after-tax employee contributions from a 401(k) plan.
- Permissible withdrawals from an eligible automatic contribution arrangement.
COVID-related distributions are not limited to distributions of amounts withdrawn solely to meet a need arising from COVID‑19. For example, a Qualified Individual may take a COVID-related distribution without regard to the Qualified Individual’s need for funds and the amount of the distribution does not need to correspond to the extent of the individual’s adverse financial consequences.
Money Purchase and Defined Benefit Plans
Under the CARES Act, a COVID-related distribution is not treated as violating the distribution requirements applicable to 401(k), 403(b), and governmental 457(b) plans. This means a 401(k), 403(b), or governmental 457(b) plan may permit a COVID-related distribution even if it would occur before an otherwise permitted distributable event, such as severance from employment, disability, or attainment of age 59 ½.
The CARES Act, however, does not change when distributions are permitted to be made from money purchase plans or defined benefit plans. This means a money purchase plan or defined benefit plan cannot make a COVID-related distribution before it would otherwise be distributable under the terms of the plan even though the distribution, if made, would qualify as a COVID-related distribution.
COVID-Related Distributions (and Loans) are Optional
An employer is permitted to choose whether, and to what extent, to amend its plan to provide for COVID-related distributions and/or loans. For example, an employer may add COVID‑related distributions and not change its plan loan provisions to increase the loan amount or suspend loan repayment schedules.
The employer or plan administrator is permitted to develop any reasonable procedures for identifying which distributions are treated as COVID-related distributions. But, the plan must be consistent in its treatment of similar distributions.
The total amount of COVID-related distributions that may be made to any single Qualified Individual from an employer’s retirement plans is $100,000. This limit applies on an aggregated basis to all plans maintained by the employer and all other employers in the same controlled group. A plan will not fail to comply with the $100,000 limit merely because a Qualified Individual’s total COVID-related distributions exceed $100,000 due to distributions taken from IRAs or plans maintained by unrelated employers.
Direct Rollover, Special Tax Notice, and 20% Withholding Not Applicable
If a plan treats a distribution as a COVID-related distribution, the rules for eligible rollover distributions are not applicable to the distribution. This means: (1) the plan is not required to offer the Qualified Individual a direct rollover of the distribution; (2) the plan administrator is not required to provide a special tax notice; and (3) the payor of the COVID‑related distribution is not required to withhold 20% of the distribution for income tax purposes. The COVID-related distribution is subject to the voluntary income tax withholding requirements, however.
Reporting COVID-Related Distributions to the IRS
The plan must report payment of a COVID-related distribution on IRS Form 1099‑R (Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.). Reporting is required even if the participant repays the COVID‑related distribution to the same plan in the same year. If the payment is treated as a COVID-related distribution and no other appropriate code applies, the payor is permitted to use either distribution code 2 (early distribution, exception applies) or distribution code 1 (early distribution, no known exceptions) in box 7 of Form 1099-R.
Recontributions of COVID-Related Distributions
A Qualified Individual who receives a COVID‑related distribution that is eligible for tax-free rollover treatment is permitted to recontribute, at any time in a three-year period, any portion of the distribution to an Eligible Plan that accepts eligible rollover contributions.
Even though a hardship distribution would not normally be an eligible rollover distribution, a hardship distribution made to a Qualified Individual that satisfies the requirements of a COVID‑related distribution is not treated as a hardship contribution, and is therefore eligible for recontribution to an Eligible Plan.
A COVID-related distribution paid to a Qualified Individual as a non-spouse beneficiary cannot be recontributed.
If a plan accepts rollover contributions, the plan is required to accept recontributions of COVID‑related distributions and to treat those recontributions as rollover contributions. Conversely, if a plan does not accept rollovers, it need not be amended to add rollover contributions and is not required to accept recontributions.
The CARES Act temporarily increases the allowable plan loan amount and permits suspension of payments for plan loans outstanding on or after March 27, 2020, for loans made to Qualified Individuals. An employer is permitted to choose whether, and to what extent, to apply the COVID‑related plan loan rules.
Increase in Allowable Plan Loan Limit
The maximum permissible loan amount is temporarily increased for loans made to Qualified Individuals before September 23, 2020, to the lesser of:
- $100,000 (versus $50,000) reduced by the amount of any outstanding loan; or
- The participant’s account balance (versus 50% of the participant’s account balance).
Suspension of Payments and Extension of Loan Term
Under the CARES Act, loan repayments due from Qualified Individuals between March 27, 2020, and December 31, 2020, may be suspended, even if the suspension results in a loan repayment after the end of the statutory maximum five-year loan repayment period. Subsequent repayments must be adjusted to reflect the delay and interest accrued during the delay.
The Notice provides a safe harbor for satisfying the CARES Act COVID-related loan suspension and extended loan term provisions. Under this safe harbor, these provisions are treated as satisfied if a Qualified Individual’s loan repayments are suspended for any period beginning not earlier than March 27, 2020, and ending no later than December 31, 2020 (Suspension Period). Loan repayments must resume after the end of the Suspension Period (i.e., beginning in January 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. The loan may be reamortized and repaid in substantially level installments over the remaining period of the loan (that is, five years from the date of the loan, assuming the loan is not a principal residence loan, plus up to one year from the date the loan was originally due to be repaid). If an employer, under its plan, initially chooses to permit a Suspension Period that is less than the maximum, the employer may subsequently extend the Suspension Period up to the maximum, but not beyond December 31, 2020.
The Treasury and IRS recognize there may be additional ways to administer the suspension and extended loan term provisions. The Notice includes an example where payments recommence in January 2021 at the original payment amount (as required by the CARES Act), with reamortization (taking into account both the suspended and 2021 payments) delayed until the one‑year anniversary of the suspension period.
Permitted Cancellation of Deferral Election under Nonqualified Plan
Under the Treasury Regulations for Code Section 409A, a nonqualified deferred compensation plan (Nonqualified Plan) may be written to provide for cancellation of a service provider’s deferral election when the service recipient takes a hardship distribution from the employer’s 401(k) plan and/or to allow a service recipient to cancel the service recipient’s deferral election due to an unforeseeable emergency (as defined in the Code Section 409A regulations).
The Notice indicates that if a service provider receives a distribution from a 401(k) plan that constitutes a COVID-related distribution, that distribution will be considered a hardship distribution for purposes of the Code Section 409 regulations. As a result, if a Nonqualified Plan provides for cancellation of the service provider’s deferral election when the service recipient takes a hardship distribution from the employer’s 401(k) plan and the service provider takes a COVID-related distribution from the employer’s 401(k) plan, the service recipient’s Nonqualified Plan deferral election must be cancelled. Furthermore, if a Nonqualified Plan allows a service recipient to cancel the service recipient’s deferral election due to an unforeseeable emergency and the service recipient takes a COVID-related distribution from the employer’s 401(k) plan, the service recipient is permitted to cancel the Nonqualified Plan deferral election.
Any Nonqualified Plan deferral election cancelled in connection with a COVID-related distribution must be cancelled for the remainder of 2020, not merely postponed or otherwise delayed. The service provider may make a new Nonqualified Plan deferral election for 2021 during the Nonqualified Plan’s customary election period.
For non-governmental employer plans, the amendment deadline is the last day of the first plan year on or after January 1, 2022 (December 31, 2022, for calendar year plans). For governmental plans, the amendment deadline is the last day of the plan year beginning on or after January 1, 2024 (December 31, 2024, for calendar year plans). The Notice indicates these dates may be extended in future guidance.
Implications for Employers
Employers may want to contact their plan recordkeeper: (1) regarding preparation and distribution of participant communications explaining the key provisions of the Notice, particularly the expanded definition of Qualified Individual; (2) to confirm that distribution and loan forms are being updated for the expanded definition of Qualified Individual as needed; (3) to confirm the recordkeeper intends to use the sample participant certification contained in the Notice or something similar; and (4) to confirm the recordkeeper intends to follow the Notice’s safe harbor for loan suspensions, and if not, determine how they will be handled.
If the employer maintains a Nonqualified Plan, the employer should review its Nonqualified Plan to determine whether it provides for cancellation of a deferral election when a participant takes a hardship distribution from the employer’s 401(k) plan. If so, the employer needs to coordinate with payroll to cancel the deferral elections for 2020 for any participants who have already received a COVID‑related distribution and to establish policies and procedures for cancelling the 2020 deferral elections of any participants who take a COVID-related distribution during the remainder of 2020.
For More Information on COVID‑19 Compliance
Warner is here to help! Visit Warner’s COVID‑19 Resource Center for the latest insight into COVID‑19 developments.
If you need assistance with implementing the CARES Act retirement plan provisions, please contact Lisa Zimmer, Jennifer Watkins, or any member of Warner’s Employee Benefits and Executive Compensation Practice Group.