CARES Act Update: Retirement Plan Distribution Relief
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted on March 27, 2020. Since then, the IRS has issued several Notices with additional information and guidance related to the CARES Act including the tax rules applicable to employer-sponsored qualified retirement plans and individual retirement accounts (IRAs). Individuals and plan sponsors should be aware of these key provisions. Here are the highlights...
CARES Act Coronavirus-Related Distributions
The CARES Act permits eligible tax-qualified retirement plans, including 401(k), 403(b), and IRAs, to allow for Coronavirus-related distributions (“CRDs”) during the calendar year 2020. If defined contribution plans already permit in-service distributions and/or hardship withdrawals, these CRDs will most likely supplement those provisions. Plan sponsors will want to review their plans to determine if any amendments may be necessary in order to provide for CRDs.
Qualified participants under the age of 59 1/2 can withdraw an additional $100,000 from their plan accounts without subjecting themselves to a 10% early withdrawal penalty. Although the distribution is a taxable event, the tax burden can potentially be paid over a three-year period. The participant can elect to include the distribution amount in their income in full during 2020, or pro rata over 2020, 2021 and 2022. Moreover, if the participant decides to re-contribute all or some of the amount to their plan account(s) at any time before the end of the third year, the Internal Revenue Service will treat such as a rollover contribution. What does that mean? Well, the amount re-contributed will be tax-free. Unfortunately, if the rollover is completed in year 2 or 3, amended tax returns will need to be filed to claim a refund of the tax on the previously -reported distributions.
For example, if a participant chooses to withdraw the full $100,000 CRD during 2020 and elects to report pro rata over 2020, 2021 and 2022, but then re-contributes the full amount in 2022, the reporting would look like this: report taxable CRD income in both 2020 and 2021 of $33,333 and $0 in 2022. In addition, the participants will need to file amended returns for 2020 and 2021 to claim a refund for taxes already paid during the first two years of the three-year period.
It is important to note that this is different from a normal hardship distribution and as such special qualifications do apply:
As expanded under Notice 2020-50, you are a qualified individual/participant if –
- You, your spouse or a dependent is diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention;
- You, your spouse or a member of your household experiences adverse financial consequences as a result of:
- being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19;
- being unable to work due to lack of childcare due to COVID-19; or
- closing or reducing hours of a business that you own or operate due to COVID-19, or
- having pay or self-employment income reduced due to COVID-19, or
- having a job offer rescinded or start date of a job delayed due to COVID-19
CRD Changes and Qualified Individuals
The burden on administrators of eligible retirement plans is also lessened as it relates to the CRD changes. They may rely on an individual's self-certification that the individual satisfies the conditions to be a qualified individual in determining whether a distribution is a coronavirus-related distribution. Remember, as always, the burden of proof will be on the taxpayer if audited by the IRS. Although it is optional for employers to adopt the distribution rules (they may not treat a distribution as a CRD), a qualified individual may still treat it as such on their federal income tax return as long as the requirement is met.
A list of FAQs related to CRDs can be found here.
Increase in Plan Loan Amount and Delay in Loan Repayments
Defined contribution retirement plans may also provide increased access to plan loans to qualified individuals through September 22, 2020, only. Loans will be permitted up to the lesser of $100,000 or 100 percent of a participant’s vested account balance, increased from the normal rule of the lesser of $50,000 or 50 percent of the vested account balance. The CARES Act allows participants the option to forego existing loan repayments through December 31, 2020 (and grants an extension of the normal five-year repayment period).
Once again, plan sponsors should review their employee benefit plans to determine if there should be any amendments to plan documents in order to allow for and provide this relief option to participants.
Waiver of Required Minimum Distributions for 2020
The CARES Act eliminates the required minimum distributions (“RMDs”) from defined contribution plans and IRAs for and due in 2020 only. The language of the CARES Act regarding waiver of the RMD rules was rather open-ended in the beginning and it was unclear whether the suspension is optional or mandatory and to which types of RMDs it applies to.
However, on June 23, 2020, the IRS issued Notice 2020-51 and clarified some lingering questions with additional guidance:
RMDs Not Yet Taken. For 2020 RMDs that have not yet been taken, this is clear—no distribution is required (which would include 2020 RMDs deferred to 2021 but required to be taken by April 1, 2021).
It is suggested that those who have RMDs automatically taken out by IRA custodians should confirm with the custodian whether the RMD will still be processed, or if the taxpayer needs to manually cancel the transaction.
RMDs Already Taken in 2020. Generally, RMDs cannot be rolled over to an IRA or other qualified account. However, due to the retroactive effect of the CARES Act (to include all of 2020), a distribution that was initially intended to be an RMD for 2020 is no longer an RMD—it has now become an eligible rollover distribution. This means a participant of a defined contribution plan or IRA owner/beneficiary who has already received an RMD distribution may repay the distribution to the distributing IRA or plan and it will be treated as a non-taxable rollover.
This does include 2019 RMDs taken prior to April 1, 2020, for those who turned 70 1/2 during 2019 as well as RMDs for inherited IRAs.
Extension of the 60-day rollover period. The notice provides that individuals now have an extension of the normal 60-day rollover deadline and must complete the rollover by August 31, 2020, to avoid taxation on the rolled-over amount.
Final things to note:
- The RMD waiver does not apply to defined benefit pension plans.
- The taxpayer has no recourse for clawing back any taxes withheld from the distribution. Thus, upon repayment/rollover, there will be a need to either (a) replace the withheld amount with out-of-pocket funds to effectively roll over the full distribution, or (b) incur a partial taxable distribution equal to the amount withheld.
- The RMD changes must also be coordinated with the SECURE Act (as enacted on December 20, 2019), which delayed the required beginning date for participants that had not yet attained age 70-and-a-half by December 31, to April 1 of the year after they attain age 72. Plan sponsors and individuals should coordinate these changes with their third-party administrators and/or custodians of IRAs.
- The rollover will not count for purposes of the one rollover per 12-month period limitation
- The life expectancy table and age factor are not impacted. In 2021, the RMD(s) will be calculated normally using the taxpayer’s respective age factor.