In the second of a series, our benefits team takes an in depth look at the provisions of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act” or the “Act”) affecting retirement plans. For a description of changes affecting health and welfare plans, see our prior post.

Retirement Plans

Tax-Favored Coronavirus-Related Distributions

The CARES Act introduces a new category of withdrawals, referred to as “coronavirus-related distributions,” under retirement plans. These withdrawals are eligible for beneficial tax treatment that is not available to withdrawals from retirement plans that do not satisfy the requirements of a coronavirus-related distribution.

Definition of Coronavirus Distribution

A “coronavirus-related distribution” is a distribution from an eligible retirement plan (i.e., a tax-qualified retirement plan, 457(b) plan of a governmental employer or individual retirement account) that meets the following requirements:

• It does not (together with any other “coronavirus-related distributions” for the employee’s taxable year) exceed $100,000;
• It is made on or after January 1, 2020 and before December 31, 2020;
• It is made to an individual who meets one of the following requirements (a “Qualified Individual”):
  • the individual is diagnosed with the virus SARS-COV-2 or COVID-19 (the “Viruses”) by a test approved by the Centers for Disease Control and Prevention (a “CDC Test”);
  • the individual has a spouse or dependent who is diagnosed with one of the Viruses by a CDC Test; or
  • the individual experiences adverse financial consequences as a result of (i) being quarantined, (ii) being furloughed, laid off or having work hours reduced due to one of the Viruses, (iii) being unable to work due to lack of child care due to one of the Viruses, or (iv) closing or reducing hours of a business owned or operated by the individual due to one of the Viruses.

A plan may rely on the employee’s certification that he or she satisfies the eligibility conditions for a coronavirus-related distribution. We await guidance from the IRS on the standards for self-certification, including whether those standards will be similar to those applied to hardship events under Section 401(k) plans (explained here). In the meantime, adhering to the hardship guidance seems like a relatively safe approach.

Plan Qualification

The CARES Act provides that a plan will not be treated as violating any provision of the Internal Revenue Code of 1986, as amended (the “Code”), by offering coronavirus-related distributions unless the amount of the coronavirus-related distributions to an individual from the plan and all other plans within the plan sponsor’s controlled group (generally, companies connected through at least 80 percent ownership interests) exceeds $100,000. It is not yet clear how these provisions will be applied to defined benefit plans and money purchase pension plans.

Exception from Early Withdrawal Penalty

Section 72(t) of the Code generally imposes a 10 percent additional income tax on any amount received by an individual as an early distribution from a qualified retirement plan. This is often referred to as the “early withdrawal penalty.” Certain types of distributions were already exempt from the early withdrawal penalty prior to the enactment of the Act, such as distributions after the employee’s attainment of age 59-1/2. Those exceptions remain in place and have been expanded by the CARES Act to include coronavirus-related distributions.

Repayment and Special Rollover Rules

Generally, if an individual receives a distribution from a qualified retirement plan, the individual is taxed on the amount of the distribution unless it is contributed to an eligible retirement plan (such as an IRA or qualified plan) within 60 days of receipt of the distribution. Any such distribution is also subject to mandatory 20 percent withholding at the time of the distribution (unless the distribution is rolled over in a trustee-to-trustee (or “direct”) rollover from the distributing plan to the receiving plan).

The CARES Act provides that a coronavirus-related distribution is not treated as an eligible rollover distribution for purposes of the mandatory withholding rules and, therefore, such a distribution is exempt from the mandatory 20 percent withholding requirements. In addition, the 60-day rollover limitation is extended in the case of coronavirus-related distributions. If an individual receives a coronavirus-related distribution, he or she may, at any time during the three- (3-) year period beginning on the day after the distribution was received, make one or more contributions (“Coronavirus Repayments”) to an eligible retirement plan (such as an IRA or qualified plan) of which the individual is a beneficiary in an aggregate amount not exceeding the amount of the coronavirus-related distribution. An amount equal to the Coronavirus Repayments will be treated as an eligible rollover distribution that was transferred to an eligible retirement plan in a trustee-to-trustee transfer within 60 days of the original distribution—that is, within the normal rollover period.

Changes to Income Inclusion

The taxable amount of any coronavirus-related distribution will be included in the individual’s gross income ratably over the three- (3-) year period beginning with the taxable year in which the amount is first to be included in income. This rule applies unless the individual affirmatively elects otherwise. It is not clear how Coronavirus Repayments will be integrated with the provisions allowing for taxation of a coronavirus-related distribution over a three- (3-) year period, particularly where an individual makes Coronavirus Repayments after one (1) or more years of income tax has become payable.

Treatment of Other Distributions as Coronavirus Distributions

The CARES Act outlines the tax treatment of coronavirus-related distributions received by an individual. The language of the Act provides that the special tax treatment applies to a distribution from a qualified plan (or IRA) to a Qualified Individual if the distribution meets the timing and dollar limitations for coronavirus-related distributions, and there is no specific requirement that the plan itself must provide for coronavirus-related distributions per se. For example, if a plan provides for hardship distributions but does not provide for coronavirus-related distributions and a participant takes a distribution that meets the plan’s requirements for a hardship distribution, and if the distribution also meets the requirements of a coronavirus-related distribution (that is, it is made within the time/dollar limits to a Qualified Individual), the statutory language suggests that the individual should be entitled to the special tax treatment afforded coronavirus-related distributions. Currently, however, despite the statutory language, it is not clear whether the IRS will apply the coronavirus-related distribution tax treatment to plan distributions that do not otherwise provide for such distributions. We understand that the IRS may be issuing guidance on this issue in the near future.

Modified Plan Loan Rules

The CARES Act modified certain plan loan rules to increase the ability of plan participants to take loans from their plan accounts and to delay repayment of those loans.

Dollar Limitations

Section 72(p) of the Code provides that plan loans that meet certain requirements are not treated as a distribution from the plan and, therefore, are not subject to taxation as a distribution. Generally, Section 72(p) provides that the maximum amount of a loan cannot exceed the lesser of $50,000 or the greater of (a) 50 percent of the participant’s vested accrued benefit under the plan or (b) $10,000. The $50,000 may be further reduced by other outstanding plan loans. The CARES Act provides that, in the case of any loan made to a Qualified Individual during the six-month period beginning on March 27, 2020 (the date of enactment of the CARES Act):

• the $50,000 loan limit is increased to $100,000; and
• the alternative limitation relating to one-half of the participant’s vested accrued benefit is increased to 100 percent of the present value of the participant’s vested accrued benefit.

Delayed Repayment

Section 72(p) of the Code generally provides that, in order to be nontaxable, a plan loan must be repaid within five (5) years (subject to a longer period for loans used to acquire the participant’s principal residence) and the loan must require substantially level amortization over the term of the loan with payments no less frequently than quarterly. The CARES Act makes the following changes in the case of Qualified Individuals with outstanding plan loans on or after March 27, 2020:

• if the due date for any repayment of the loan (including loans to acquire a primary residence) occurs during the period beginning on March 27, 2020 and ending on December 31, 2020, the due date will be delayed for one (1) year and the one- (1-) year delay period will be disregarded for purposes of determining whether the loan meets the maximum term and level amortization requirements of Section 72(p); and
• any subsequent repayments will be appropriately adjusted to reflect the delay in the due date described above.

It appears that the modifications made to Section 72(p) are required rather than permissive. Note also that Section 408(b)(1) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and regulations issued thereunder also include requirements for plan loans that must be satisfied in order for the loan to be exempt from the prohibited transaction rules of ERISA. Some of those rules are implicated by the changes included in the CARES Act even though the CARES Act addresses only changes in the requirements under Section 72(p) of the Code. For example, the Department of Labor (“DOL”) regulations under Section 408(b)(1) of ERISA provide that an extension or renewal of a loan is treated as a new loan (requiring a test of the applicable limits, the interest rate, etc.). It is assumed that the DOL will issue guidance that will be consistent with the changes made to Section 72(p), but such guidance has not yet been issued.

Plan Amendments

The CARES Act generally provides that amendments to reflect the foregoing provisions (or any related provisions required by applicable Treasury or DOL regulations) will not need to be made until the last day of the first plan year beginning on or after January 1, 2022 (January 1, 2024 in the case of a governmental plan). In addition, an amendment made in accordance with the foregoing will not cause the plan to fail to satisfy the requirements of Section 411(d)(6) of the Code or Section 204(g) of ERISA (relating to prohibitions on the cut-back or elimination of accrued benefits and benefits, rights and features). The plan will need to be operated in accordance with any amendments so made.

Temporary Waiver of RMDs

The CARES Act amends Section 401(a)(9) of the Code to provide a temporary waiver of the required minimum distribution (“RMD”) requirements with respect to most types of defined contribution plans. For calendar year 2020, the RMD requirements do not apply to plans of the following types:

• Tax-qualified defined contribution plans, such as 401(k) plans;
• Code Section 403(a) and 403(b) plans;
• Eligible non-qualified deferred compensation plans described in Section 457(b) of the Code, but only if maintained by a governmental employer; and
• Individual retirement plans (IRAs).

The CARES Act includes a special rule clarifying that the waiver applies to any distribution required to be made in 2020 by reason of a required beginning date occurring in 2020, which distribution was not made before January 1, 2020. The required beginning date with respect to any individual shall be determined without regard to the waiver for calendar years after 2020. Further, with respect to the requirement (when applicable) that an employee’s interest in the plan be distributed within five (5) years after the employee’s death if the employee dies prior to distribution commencement, the five- (5-) year period shall be determined without regard to calendar year 2020.

Additionally, if all or any portion of a distribution during 2020 is treated as an eligible rollover distribution, but would not be treated as such if the RMD requirements had applied during 2020, such distribution (or portion thereof) shall not be treated as an eligible rollover distribution for purposes of the direct rollover rule or the 20 percent mandatory withholding rule. This means that distributions taken in 2020 that would have been considered RMDs but for the waiver may be rolled over, but are not subject to the direct rollover requirement or mandatory 20 percent withholding. A plan does not have to offer a direct rollover opportunity to an individual receiving such a distribution or withhold from such distribution at a rate of 20 percent. The individual could elect to have a different withholding rate, or to have no withholding, apply to the distribution.

The deadline for amending plans and contracts to provide for the waiver is the last day of the first plan year beginning on or after January 1, 2022 (January 1, 2024, in the case of a governmental plan). Plans will not be treated as failing to operate in accordance with their terms if they are timely amended and operate during calendar year 2020 as though the plan or amendment were in effect. In addition, an amendment made in accordance with the foregoing will not cause the plan or contract to fail to satisfy the requirements of Section 411(d)(6) of the Code or Section 204(g) of ERISA (relating to prohibitions on the cut-back or elimination of accrued benefits and benefits, rights and features).

Single-Employer Plan Funding Relief

The CARES Act includes certain funding relief provisions that apply to single-employer defined benefit plans.

2020 Minimum Required Contributions Holiday

The CARES Act defers, until January 1, 2021, any single-employer defined benefit plan contributions required under Section 430(a) of the Code that would otherwise be due in 2020, including quarterly contributions due in 2020. The amount of any minimum required contribution that is deferred must be increased by interest accruing between a contribution’s original due date and the date on which the contribution is paid, at the plan’s effective rate of interest for the plan year that includes the payment date. For many employers who sponsor defined benefit plans, this will free up much-needed cash.

Elective Use of Prior Year AFTAP in Determining Plan’s Funding Percentage

Section 436 of the Code restricts a defined benefit plan’s ability to provide continued benefit accruals, pay lump sums, improve benefits, and certain other restrictions if the plan has not attained certain specified funding levels. The most severe restrictions come into effect if a plan’s “adjusted funding target attainment percentage” (“AFTAP”) for a plan year is less than 60 percent. Restrictions generally cease to apply if a plan’s AFTAP is 80 percent or higher, unless the plan’s sponsor is in bankruptcy. The CARES Act allows a defined benefit plan sponsor to elect to treat a plan’s AFTAP for the last plan year ending before January 1, 2020 as the AFTAP for the plan year that includes calendar year 2020. This may allow a defined benefit plan with an AFTAP of less than 80 percent for its plan year that includes calendar year 2020 (presumably, any calendar year plan and any plan year that ends in calendar year 2020) to avoid unanticipated restrictions on lump sums and the other restrictions imposed on underfunded plans by using its prior year AFTAP in determining the plan’s funding level for such year.

Expansion of DOL Authority to Postpone Deadlines

The CARES Act amends Section 518 of ERISA to expand the DOL’s authority to postpone the deadline, by up to one (1) year, for any filing or other action required or permitted to be completed by ERISA due to a public health emergency (“PHE”) declared by the Secretary of Health and Human Services (“HHS”).

Prior to its amendment, Section 518 of ERISA provided the DOL with such authority in the case of any Presidentially-declared disaster or a terroristic or military action. Section 518 applies broadly to benefit plans as well as to plan sponsors, administrators, participants, beneficiaries and other persons with respect to plans that are affected by such a disaster or emergency.

On January 31, 2020, the HHS Secretary declared a PHE retroactive to January 27, 2020 for the entire United States for COVID-19. The DOL could potentially extend the deadline for filing Form 5500 annual reports, or deadlines relating to other ERISA requirements, due to the COVID-19 state of emergency. Examples of deadline extensions pursuant to ERISA Section 518 in connection with previous federally declared disasters have included certain deadlines affecting COBRA continuation coverage, special enrollment, benefit claims, appeals of denied claims, and external review of certain claims. As of the date of this publication, no such ERISA extensions have officially been made yet related to the COVID-19 state of emergency.

Sponsor/Plan Administrator Considerations Related to Retirement Plan Provisions

• Consider whether coronavirus-related distributions are going to be permitted under the company’s tax-qualified defined contribution plans and, if so, what the parameters will be (g., which contributions can be withdrawn, what will be the limitations?).
• Consider whether plan amendments are needed to document the availability of coronavirus-related distributions. For example, if expanded distribution rights are not going to be provided, it may not be necessary to amend the plan document (although it may be necessary to amend procedures around distributions to ensure that participants receive proper tax treatment).
• Discuss coronavirus-related distribution process (g., obtaining certifications, method for requesting, etc.) and reporting with plan recordkeeper. No guidance has yet been issued on any actual process, although it may be helpful in the absence of specific guidance to analogize the process to other types of special distributions (such as relief provided in the past for distributions relating to hurricanes or qualified reservist distributions).
• Consider whether plan amendments or amendments to operative documents (g., loan agreements) are needed to document changes in the loan repayment provisions for existing loans.
• Discuss loan repayment and limitation provisions with plan recordkeeper to ensure proper treatment and reporting.
• Consider payroll implications and how/when payroll changes need to be implemented; consider the methodology to keep track of reinstatement of loan payments and new due dates after extension.
• Contact plan service providers regarding RMD waivers to address administration, reporting, and the timing, manner and content of participant communications.
• If plan participants have access to a call center, contact the applicable vendor to determine its preparedness to handle participant inquiries about how the CARES Act affects plan benefits.
• Monitor announcements for DOL extended deadlines.

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