The Internal Revenue Service has been busy issuing guidance over the last month or so on various retirement benefit issues. We want to be sure you are aware of these important updates.
Retirement plan and IRA liquidity options
We have previously discussed the relief provided under the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) for individuals with various forms of tax-favored retirement arrangements, including 401(k) and other types of qualified plans, individual retirement accounts (IRAs) and 403(b) plans, among others. In Notice 2020-50, the IRS answered several unresolved questions about, and dramatically expanded the availability of, Coronavirus Related Distributions (CRDs). As a reminder, the aggregate amount of distributions eligible to be treated as CRDs by an Affected Individual is $100,000.
Coronavirus Related Distributions – Under the CARES Act, an individual eligible to receive a CRD (an “Affected Individual”) is a person (1) who is (or was) diagnosed with COVID-19, (2) has a spouse or dependent who is (or was) diagnosed with COVID-19 or (3) who experiences (or who has experienced) adverse financial consequences as a result of quarantine, furlough, layoff, reduction in work hours or child care issues due to the coronavirus emergency. The Notice significantly expands the third category in two ways. First, it expands the scope of additional adverse financial consequences to include reductions in pay (or self-employment income) due to COVID-19 or having a job offer rescinded (or start date delayed). Second, the Notice provides that if the adverse financial consequence happens to the individual’s spouse or someone who shares the individual’s principal residence, the individual is treated as an Affected Individual for CRD eligibility purposes.
Not surprisingly, the Notice did not change the deadline for taking a CRD, which is no later than December 30, 2020. It did, however, confirm that an Affected Individual may treat a distribution as a CRD even if the distribution is (or was) not directly tied to a COVID-19 related need. This is in contrast, for example, to a hardship withdrawal where the distribution is limited to the amount necessary to relieve the hardship, plus a tax gross-up.
While on the topic of hardship withdrawals, the Notice provides that if a distribution could satisfy both the hardship withdrawal criteria and the criteria for a CRD, an Affected Individual may treat the distribution as a CRD – meaning, among other things, that taxation is spread over a three-year period, any otherwise applicable 10% early withdrawal excise tax is avoided and the amount can be recontributed. This approach is consistent with the IRS’s view that many types of distributions to an Affected Individual in 2020 (including, for example, a minimum required distribution (MRD) received early in 2020 before the CARES Act waiver became law or a defaulted loan offset in 2020) are potentially eligible to be treated as a CRD. That said, there are some types of distributions such as corrective distributions of limit or nondiscrimination testing violations that can never be treated as CRDs.
Finally, the Notice states that while a beneficiary of a deceased participant or IRA account owner may be eligible to benefit from CRD treatment (if an Affected Individual), a beneficiary does not have the ability to recontribute the amount to a retirement arrangement, as would another Affected Individual.
Plan related provisions – The Notice clarifies that a retirement plan may (but need not) add a CRD option. If a CRD option is added, a profit sharing or stock bonus plan may provide that some or all contribution sources are available for this purpose, including 401(k) contributions, matching contributions, profit sharing contributions, safe harbor contributions, QNECs and QMACs, even if the individual has not terminated employment or attained age 59½. Money purchase pension plans and defined benefit plans, however, cannot permit a CRD before any otherwise applicable in-service distribution date (historically age 62, but that age was recently dropped to age 59½), and for these plans, spousal consent is required if the distribution is made in a form other than a qualified joint and survivor annuity.
The guidance notes that if a plan sponsor offers CRDs, it must apply the $100,000 limit across all plans maintained by members of the controlled group. A plan making a CRD must also be consistent in its approach, meaning that although CRDs are treated as eligible rollover distributions for purposes of allowing recontributions, the usual eligible rollover distribution rules (including the requirement to offer a direct rollover, delivery of a 402(f) notice and mandatory 20% federal income tax withholding) do not apply. Instead, the “mandatory” 10% federal income tax withholding rules that apply to distributions that are not eligible rollover distributions apply.
On the question of whether a retirement plan must accept a repayment of CRDs, the guidance is unclear, providing simply that retirement plans that accept rollovers are “anticipated” to accept recontributions of CRDs. Our current view remains that if a plan permits rollover contributions, it should permit CRD rollovers back into the plan.
Finally, the Notice includes a form of safe harbor certification of Affected Individual status on which a plan administrator may rely, absent actual knowledge to the contrary.
Income tax issues associated with a CRD – Helpfully, the new guidance clarifies that an Affected Individual may treat otherwise eligible distributions as CRDs, even if a plan administrator, IRA custodian or other relevant party does not treat and report the distribution as a CRD.
While by default a CRD is includible in federal income ratably in 2020, 2021 and 2022, an Affected Individual can elect to include the entire amount in income for 2020. The Notice provides that this decision is irrevocable once the 2020 tax return (including valid extensions) is filed, and that the decision applies to all amounts eligible to be treated as CRDs.
The Notice confirms that in the event a CRD is included in income and later repaid after an applicable tax return has been filed, an amended federal income tax return may be necessary to recover any taxes paid on the CRD, although other options are available under the Notice. Part of the initial reporting of a CRD, and any recontribution/refund process, will include new federal Form 8915-E, Qualified 2020 Disaster Retirement Plan Distributions and Repayments.
Finally, the Notice provides that a CRD will not adversely affect an individual who is receiving “substantially equal periodic payments,” one of the few exceptions to the 10% early withdrawal excise tax when the recipient is not yet age 59½. A recontribution within three years of the CRD is also not considered to be a rollover for purposes of the IRA one rollover in a 12-month period rule.
As a reminder, not all states will necessarily conform to the federal income tax treatment of a CRD and individuals are urged to consult with their own tax or financial advisors.
Loan related relief – Provided a plan adopts this provision, Affected Individuals are also eligible for loans of up to $100,000 or 100% of the individual’s vested balance, if less, provided the loan is made on or after March 27, 2020 and before September 23, 2020. In addition, a plan may provide that loan repayments due through the end of 2020 for an Affected Individual’s loan outstanding on or after March 27, 2020, including a loan described in the preceding sentence, may be deferred for one year. The Notice provides a safe harbor reamortization method for implementing these changes but also acknowledges that other approaches may be reasonable. Either way, we anticipate that this additional guidance will address the legitimate recordkeeper concerns about how to offer this type of relief. Finally, the hoped for prohibited transaction relief that we mentioned in our earlier advisory has been provided.
Nonqualified deferred compensation plans – The Notice provides that a CRD from an employer’s retirement plan will be treated as a hardship distribution for purposes of Internal Revenue Code Section 409A. As a result, an Affected Individual is generally able to cancel his or her deferral election under a nonqualified deferred compensation arrangement.
Heads up on retirement plan document updates
For clients that utilize pre-approved defined contribution plan documents (a prototype or volume submitter document, typically provided by a recordkeeping vendor), the time to amend and restate the entire plan is fast approaching.
Several years ago, the IRS adopted a six-year restatement cycle for pre-approved plans. In Announcement 2020-7, the IRS stated that as of June 30, 2020, it would begin to provide updated “opinion letters” for the third six-year cycle. Plan sponsors that use a pre-approved plan will have a two-year window – beginning August 1, 2020 and ending July 31, 2022 – in which to adopt the updated plan document. We expect that clients that use a pre-approved plan will likely begin to hear from pre-approved plan document providers over the Summer.
Spousal consent in the age of COVID-19
Notices can be provided to, and elections may be made by, retirement plan participants using electronic means if certain requirements are satisfied. In the case of a required spousal consent, however, applicable regulations permit use of an electronic signature and notarization process by a spouse only if the spousal signature (electronic or otherwise) is provided in the physical presence of a notary or plan representative. The Treasury Department, in issuing the regulation providing for this process, sought to balance the rights of spouses with administrative burden.
COVID-19 of course has changed much of what was once considered “normal,” including the idea of physical proximity. In response to requests, Notice 2020-42 provides for the relaxation of the physical presence requirement for all of 2020, meaning that as long as the notary or plan representative is able to witness the signature process via live audio-video technology, and provided that all other applicable requirements of the new guidance, Treasury Regulations and state law (in the case of notarization) are satisfied, the physical presence of the spouse before the notary or plan representative is not required in order to obtain a valid spousal consent.
2020 minimum required distribution waiver
In Notice 2020-51, the IRS provided much needed guidance to plan sponsors, plan recordkeepers, plan participants and IRA owners (and custodians) on various issues relating to MRD relief available under the CARES Act. Generally, the CARES Act waived the 2020 MRD requirement and also waived the requirement for retirement arrangements to make, and account holders to receive, a 2019 MRD if the distribution had been delayed into the January 1, 2020 to April 1, 2020 period because 2019 was the first year for which an MRD was required. (As a reminder, the MRD relief does not apply to defined benefit plans.)
Critical to individuals (plan participants and IRA owners) is a special extension until August 31, 2020 (or within 60 days of the distribution, if later) to roll over funds previously distributed in 2020 as an MRD (for example, a 2020 MRD that was automatically distributed pursuant to a standing distribution election on say January 3, 2020 – well before the CARES Act change). This special extended deadline for restoring a distribution is also available if a purported MRD was made before systems were modified to account for the shift from age 70½ to age 72 that was part of the SECURE Act at the end of 2019.
The guidance confirms that the MRD relief is available for beneficiary distributions from a retirement plan or IRA that would otherwise be required. The Notice also confirms that the CARES Act MRD change effectively adds one year to the five-year distribution period applicable to certain beneficiaries under pre-SECURE Act law. Finally, and similar to the relief mentioned earlier in the context of a recontribution of a CRD, the Notice states that an IRA recontribution will not count for purposes of the one rollover in a 12-month period rule.
Unhelpfully, but not surprisingly, the new guidance does not really address any of the open issues that arose following the extensive SECURE Act changes to the MRD rules.
Mid-year changes and safe harbor 401(k) plans
Finally, Notice 2020-52 affords plan sponsors a bit more flexibility to make mid-year changes to safe harbor (traditional and QACA) 401(k) plans. Leaving aside the SECURE Act changes to safe harbor 401(k) plans discussed in another of our advisories, mid-year changes are permitted if either the safe harbor notice (distributed before the beginning of a plan year) includes a statement to the effect that safe harbor nonelective or matching contributions may be reduced or suspended during the year (and no earlier than 30 days after notice of the reduction or suspension is provided) or if the employer is operating at an “economic loss.”
Many employers with calendar year plans did not have the foresight to anticipate the current pandemic and therefore may not have included the appropriate language about reducing or suspending contributions mid-year, or may need to make the reduction or suspension immediately and cannot wait the 30-day required period. And because the “economic loss” standard is difficult to satisfy, it may not be clear to an employer that this requirement is met.
Under the new guidance, the IRS has stated that
- A reduction or suspension of safe harbor contributions allocated solely to HCEs is permitted as long as the safe harbor notice is updated;
- An amendment to reduce or suspend safe harbor contributions adopted between March 13, 2020 and August 31, 2020 will be treated as if it satisfied the economic loss/reserved right to change notice requirements; and
- The supplemental notice for a plan amendment that reduces or suspends safe harbor nonelective contributions and that is adopted in the March 13, 2020 to August 31, 2020 period can be provided as late as August 31, 2020, as long as the plan amendment is adopted no later than the effective date of the reduction or suspension.