Inside the CARES Act: COVID-19 Impact Upon Retirement Plans/Accounts
At 880 pages, the Coronavirus Aid, Relief, and Economic Security (CARES) Act covers a lot of ground, offering COVID-19 relief and benefits to a broad swath of the population. Among its significant provisions are those related to workers’ retirement funds. Specifically, the CARES Act makes employee-favorable changes to existing law regarding:
Required Mandatory Distributions (RMDs)
While a detailed analysis of prior law and all changes made by virtue of the CARES Act is beyond the scope of this blog post, in general terms, the prior guidance and the newly enacted changes are summarized below.
Early Retirement Account Withdrawals Due to COVID-19 Hardship
Prior Rules: Hardship withdrawals have been allowed from defined contribution plans (not from IRAs) upon an employee’s certification that they lack enough cash to meet their financial needs and the distribution is to be used only for certain purposes, including the purchase or repair of a primary residence, post-secondary education expenses, medical expenses, and funeral expenses. Such withdrawals are limited to the lesser of $50,000 or 50% of the retirement account’s balance. Unlike loans (discussed below), hardship withdrawals are not repaid to the plan, so they permanently reduce the employee’s account balance. Moreover, hardship withdrawals are subject to income tax and, if the participant is younger than 59 and ½, a 10% early withdrawal penalty is assessed.
CARES Act: Among its many retirement plan provisions, for individuals (employees, their spouses, and their dependents) who have been diagnosed with COVID-19; who have experienced adverse financial consequences as a result of being quarantined, furloughed, or laid off; or who have otherwise lost income (including because of having to be home to provide child care), the CARES Act offers the following benefits with respect to early withdrawals:
The 10% penalty is waived for distributions up to $100,000 or the retirement account’s balance;
The withdrawal can be from an IRA, in addition to defined contribution plans, such as 401(k)s; and
The amounts of the COVID-19 withdrawals can be repaid to the employee’s qualified plan or retirement account (e.g., IRA, SEP, and/or Simple IRA) and, to the extent such repayment occurs within three years, the amounts repaid will not be subject to tax (until, of course, withdrawals are again made in the normal course).
Retirement Plan Loans
Prior Rules: IRS Rules permit, but do not require, plan sponsors (typically employers) to include loan provisions in their qualified employee benefit plans. Those plans include profit-sharing, 401(k), 403(b), and 457(b) plans. IRAs, including SEPs and Simple IRAs, do not offer loans. If a plan allows loans to be made, the maximum amount of the loan is 1) the greater of $10,000 or 50% of the vested account balance or 2) $50,000, whichever is less. While plans can establish their own terms for borrowing and repayment, IRS rules require that, except for loans taken for the purpose of purchasing the employee’s principal residence, loans must be repaid within five years.
CARES Act: For those same individuals to whom the changes in the early withdrawal rules apply (see discussion above), the CARES Act offers several advantageous provisions regarding loans from qualified retirement plans:
The maximum amount that can be borrowed is increased from $50,000 to $100,000 and the percentage test limit also increases, from half the present value of the participant’s account balance to the entire value at the time of the loan; and
If a plan participant has an existing loan and loan repayment is due between the date of the CARE Act’s enactment and the end of the year, the Act allows the repayment to be delayed for one year from the Act allows the repayment to be delayed for one year from the original due date, with subsequent loan repayments adjusted to reflect the delay in the 2020 repayment.
Caveat: Note that, unlike the changes to the early withdrawal rules, the COVID-19-related changes to the loan rules do not expand the availability of loans to IRAs and, whether loans are permitted from qualified employee retirement plans remains subject to the terms of the plan.
Required Minimum Distributions
Prior Rules: Historically, the law required owners of retirement accounts (including IRAs, SEPs, Simple IRAs, 401(k)s, 403(b)s, profit-sharing, and other defined benefit plans) to start taking withdrawals by April 1 of the year after they turned 70 and ½. However, the SECURE Act, signed on December 20, 2019, allows RMDs by individuals whose birthday is July 1, 2019 or later to begin by April 1 of the year after they turn 72. The amount of the RMD for any year is the account balance as of the end of the preceding calendar year divided by a distribution period derived from the IRS’s “Uniform Lifetime Table.” RMDs do not apply to Roth IRAs.
CARES Act: The Act includes a provision permitting a one-year delay in RMDs. Thus, any distribution that would otherwise be due this year would be deferred to next year; and, likewise, distributions due in later years would also be deferred. Notably, the CARES Act allows account owners to skip both their 2019 RMD if it was their first year and they had not yet made an RMD by April 1, 2020, and their 2020 RMD. Unfortunately, there is no provision allowing an individual to recoup an RMD payment taken prior to the passage of the CARES Act.