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CARES Act Permits Emergency Access to Retirement Funds for Employees Affected by COVID-19 Through Relaxed Participant Distributions and Loans

By Luke D. Bailey / May 13, 2020

Liberalized Rules Apply Only if Plan Sponsor Chooses to Adopt Them

This Alert explains the way that Congress, in the CARES Act, increased the ability of employees who have been negatively affected by the COVID-19 pandemic to access their 401(k) and other qualified retirement plan savings on an emergency basis. Plan sponsors have a choice whether to implement the new rules and if the plan covers collectively bargained employees, the implementation will likely first need union consent.

A plan sponsor that wishes to implement the relaxed CARES Act qualified plan distribution and participant loan rules may do so by adopting an administrative policy; a more formal plan amendment is not required until, generally, 2022. If you want further information or need help implementing the CARES Act distribution and/or loan rules, please contact one of the Clark Hill Employee Benefits and Executive Compensation attorneys listed at the end of this Alert. Clark Hill has developed a CARES Act distribution and loan policy template that may be revised as needed with the assistance of employee benefits counsel to quickly implement the CARES Act distribution and loan rules, along with a PowerPoint deck that can be used to inform decisionmakers about the policy.

Qualifying Employees

To qualify for a CARES Act distribution or loan, an employee must meet one of the following requirements:

  • The employee or his or her spouse or dependent must have been diagnosed with SARS-CoV-2 or COVID-19, or
  • The employee must experience “adverse financial consequences as a result of being quarantined, furloughed or laid off, or having hours reduced…or other factors [as determined by IRS]”

In this Alert, we will refer to an employee or former employee who meets the above requirements as a “2020 COVID-19 pandemic-affected participant.” Importantly, the CARES Act expressly permits plan sponsors to rely on a participant’s self-certification that he or she is a 2020 COVID-19 pandemic-affected participant to apply the CARES Act distribution or loan rules to the participant. The IRS has indicated in recent guidance that the only instance in which such reliance would be impermissible is if the plan sponsor had “actual knowledge” that the participant’s certification was false.

CARES Act Distributions Enjoy Favorable Tax Treatment

CARES Act distributions (a) are not subject to the 10% premature distribution tax, regardless of the participant’s age, (b) are subject to federal income tax only ratably over the 2020-2022 period (i.e., 1/3rd of the amount of the distribution is includable in the participant’s gross income in each of 2020, 2021, and 2022), and (c) as an alternative to inclusion in gross income over the 2020-2022 period, may be rolled over by the participant at any time during the three-year period beginning with the day after the date on which the distribution was made (back into the distributing plan, to another employer’s plan, or an IRA), thereby converting the distribution into the equivalent of an interest-free loan from the plan. The combined total amount of CARES Act distributions that 2020 COVID-19 pandemic-affected participants may receive from all qualified plans and/or IRAs is limited to $100,000. CARES Act distributions must be received on or after January 1, 2020, and before December 31, 2020.

Because the federal income tax consequences of CARES Act distributions are substantially more favorable than separation from employment or conventional hardship distributions, 2020 COVID-19 pandemic-affected participants who need access to retirement plan funds to meet current needs will likely want to utilize the CARES Act distribution provisions of their plan, if made available by the plan sponsor.

For defined contribution qualified retirement plans (such as 401(k), 403(b), and 457(b) plans, but not defined benefit or so-called “money purchase pension plans) that adopt the CARES Act distribution rules, CARES Act distributions are generally available both to currently employed individuals (i.e., as in-service distributions) as well as to terminated employees who might typically be eligible to receive a distribution of their plan account or benefit even apart from the CARES Act distribution rules. Funds that might not otherwise be available for in-service distribution, for example, accumulated elective deferral amounts of a participant who has not yet attained age 59½, or 401(k) safe harbor matching or nonelective contributions, are fully available for CARES Act distributions.

CARES Act Loan Rules

In the CARES Act, Congress increased the limit on the amount that a 2020 COVID-19 pandemic-affected participant may receive as plan loans during the 180 days from March 27, 2020, through September 22, 2020, from (a) the normally applicable limit of the lesser of 50% of the 2020 COVID-19 pandemic-affected participant’s account balance or $50,000 to (b) the lesser of 100% of his or her account balance or $100,000. Also, no payment is required on a CARES Act loan until 2021, and the repayment period that would normally apply (typically, five years from the date of the loan) will be extended by up to one year to take into account the period during which no payments were required.

The CARES Act also allows plans to suspend for the remainder of 2020 any payments that would otherwise be required to be made on a participant loan that is outstanding on or after March 27, 2020, to a 2020 COVID-19 pandemic-affected participant. As with a new CARES Act loan as explained in the preceding paragraph, the otherwise applicable loan term (typically, 5 years, or potentially longer in the case of a loan that was used by the participant to purchase his or her principal residence) is extended by the period of the suspension.

Please contact any of the Clark Hill Employee Benefit and Executive Compensation attorneys identified below if you wish to know more about the CARES Act qualified plan distribution and loan rules, or wish to implement them for your plan.

Please contact these attorneys for more information: Edward C. HammondBrad OxfordLuke D. BaileyJames R. Olson, and Charles M. Russman.