In this Ropes & Gray podcast, benefits partners Loretta Richard and Josh Lichtenstein discuss the Coronavirus Aid, Relief and Economic Security Act (also known as the CARES Act) in the context of 401(k) plans and other tax-qualified defined contribution retirement plans, including coronavirus-related distributions and loans that can be taken from qualified defined contribution retirement plans, the issues plan sponsors should focus on under the CARES Act, and other issues and challenges for plan sponsors to consider related to the coronavirus more generally.
Loretta Richard: Thank you for joining us on this Ropes & Gray podcast. I’m Loretta Richard, the head of the employee benefits practice group at Ropes & Gray; I am based in Boston and I am joined by Josh Lichtenstein, who is a partner in the employee benefits practice group, based in our New York office.
Today, we will be discussing the Coronavirus Aid, Relief and Economic Security Act, also known as the CARES Act, in the context of 401(k) plans and other tax-qualified defined contribution retirement plans. We will be covering three topics today. First, we will discuss coronavirus-related distributions and loans that can be taken from qualified defined contribution retirement plans. Second, we will discuss the issues plan sponsors should focus on under the CARES Act. Finally, we will discuss other issues and challenges for plan sponsors to consider related to coronavirus more generally.
Now, there’s a lot being said about how the CARES Act allows retirement savers to access their account balances if they are experiencing coronavirus-related costs. Who is allowed to withdraw money from their retirement accounts under the Act and what types of plans do these rules apply to?
Josh Lichtenstein: The CARES Act allows a plan participant who has been diagnosed, or whose spouse or dependent has been diagnosed with COVID-19 using a test approved by the CDC, to access their retirement savings. The Act also allows individuals who experience adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19, or their being unable to work due to lack of child care because of COVID-19 or because of the closing or a reduction in hours of a business owned or operated by the individual. A coronavirus-related distribution can be taken from a 401(k) plan, an individual retirement account (or IRA), a 403(b) plan sponsored by a tax-exempt employer or a qualified deferred compensation plan subject to Section 457(b) of the tax code that is sponsored by a governmental employer.
Loretta Richard: Josh, it sounds like a large number of people may be eligible for distributions, and some of those factors seem very difficult to verify. How can a plan administrator determine if a participant is eligible for a coronavirus-related distribution?
Josh Lichtenstein: Fortunately for plan administrators, participants are allowed to self-certify that they qualify for a distribution, so the burden on plan administrators shouldn’t be that great. The best practice would be to ask for a self-certification from the participant in writing. It will be important to maintain good records of all requests and certifications. Plan administrators should check in with their record keepers, who may already be working on a self-certification form and recordkeeping system.
Loretta Richard: So Josh, once someone has established that they’re eligible for relief, or think they are eligible for relief, what amount can they withdraw from their plan? Are there any limits on it?
Josh Lichtenstein: Well, there are two ways that a participant can access their retirement savings under the CARES Act. First, they may take a CARES Act distribution of up to $100,000, and that can be taken without any penalty. Of course, they will be taxed on the amount they withdraw, but those taxes can be spread over a three-year period. Eligible participants can also take loans from their plans in a larger amount than is normally allowed, with a maximum loan amount of $100,000 instead of $50,000. Participants with large enough account balances could take a distribution and a loan, and there’s no requirement to take a loan before choosing to take a distribution.
Loretta Richard: Wow, that sounds like a lot. Based on those amounts, could many people end up taking all of the money out of their retirement plans? Will participants be required to pay back any amount of any coronavirus-related distributions in the future?
Josh Lichtenstein: That’s an important question, Loretta. The CARES Act allows for two ways to handle a coronavirus-related distribution. First, a participant may elect to pay the distribution back into his or her qualified retirement plan account. Repayment is optional, but it may be made at any time during the three-year period beginning on the day after the date the distribution was received. A participant can repay the distribution all at once, or in a series of payments over time, within that three-year period. Repayments of coronavirus-related distributions will not count toward the applicable plan year’s contribution limits, so it will not affect a participant’s ability to make new contributions to his or her qualified retirement plan in future years. This will enable participants to continue to grow their accounts while also repaying the distributions. Alternatively, a participant may elect not to pay the distribution back at all and will instead be subject to income tax on the distribution.
Loretta Richard: Josh, does the CARES Act include any special rules on loan repayments or other distributions from plans?
Josh Lichtenstein: The coronavirus-related loans will need to be repaid in the normal course, but the CARES Act permits a one-year delay on repaying participant loans that are due in 2020. This will allow people who otherwise would need to repay their outstanding loans now to hold onto that money for expenses that may arise this year. The CARES Act also allows plan sponsors to delay required minimum distributions for the 2020 plan year. This should protect plan participants from being forced to liquidate assets that have dropped in value sharply in order to take a distribution they may not actually need in 2020. One other thing to keep in mind is that if a CARES Act distribution (other than a loan) is taken, then a participant who is married will need to get spousal consent to the distribution if the plan would normally require that type of consent. Usually that involves the spousal signature being witnessed by a notary or a plan representative. Plan sponsors should talk with their recordkeepers about how the notary or plan representative witness requirements can be satisfied on a remote basis.
Loretta Richard: Josh, can plan participants automatically take advantage of these new distribution and loan rules, or does the plan sponsor need to decide to offer them?
Josh Lichtenstein: Well, the rules on distributions and loans that we have been discussing so far are all permissive, so plan sponsors must choose whether to allow participants to take CARES Act distributions or enhanced loans. The CARES Act allows plan sponsors to administer their plans under these new rules now so long as plan amendments are adopted by the last day of the first plan year beginning on or after January 1, 2022 (so, by December 31, 2022 for a calendar year plan). In addition to amendments necessary to give effect to these new rules, plan sponsors should also review whether their plan allows for loans at all and, if desired, amend their plans to allow participants to take loans. If an amendment is required, it should be adopted by the last day of the current plan year. There is no timing relief on that amendment. The choice of whether to amend the plan and how to communicate with participants is less straightforward. Plan sponsors should communicate with their recordkeepers and other third-party service providers now to learn what those vendors are doing to assist with implementation of the CARES Act, and also to learn whether there are any recordkeeping obligations that will fall on the plan sponsor instead of on the vendor. In addition, participants are likely to have heard about these CARES Act rules on plan withdrawals and loans, so there may be an expectation from employees that they will have access to their account balances. But at the same time, plan sponsors may be concerned about employees depleting their retirement savings, and may wish to offer a lower limit than $100,000 on distributions. Participant communication is really going to be key here, and plan sponsors should take action now to discuss coordinated communications strategies with their recordkeepers, including communications on the decision to take loans or to take distributions.
Loretta Richard: This seems like a lot that sponsors are going to have to think about and will have to consider in a short period of time on the CARES Act rules. Are there any other things that a plan sponsor should be thinking about during this time of disruption based on the pandemic?
Josh Lichtenstein: That is a great question, Loretta, and I think that this is a very important topic for plan sponsors. I think it’s critically important for a plan sponsor to remain mindful of its fiduciary duties to the plan and its participants under ERISA. As most plan sponsors are aware, prudence under ERISA is very process-based, so it’s very important that plan sponsors make sure that they continue to follow their regular policies and procedures for decision making, and that they keep good notes on their decision making process. This is also a good time to check in with recordkeepers, consultants and investment managers to make sure that they are all taking appropriate steps to provide the service that they normally would, even as people are working remotely. Plan sponsors should also be watching for demographic and other changes in their plans if there are furloughs or layoffs or if participants take advantage of the distribution and loan provisions we have been discussing. If participant drop offs are large enough, it could trigger a partial plan termination which would require employer matches to vest. Recordkeeping fees and mutual fund share class access may also be affected by shifts in plan size due to distributions participants take.
Loretta Richard: Thank you very much, Josh, for joining me today for this discussion. This is an extremely important topic and I am sure we'll be continuing this discussion further as we dig more deeply into these rules. And thank you to our listeners. For more information on the topic we discussed today, or other topics related to the CARES Act and COVID-19, please visit our website at www.ropesgray.com/coronavirus. And of course, if we can help you navigate any of these areas, please do not hesitate to contact any one of us. You can also subscribe and listen to other Ropes & Gray podcasts wherever you regularly listen to podcasts, including on Apple, Google and Spotify. Thanks again everyone for listening.
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