Two of these provisions make it easier for participants to access funds in their accounts either by taking an early distribution or a loan. A third provision allows retirees to suspend taking a required minimum distribution for 2020. Following is a discussion of these provisions:
- The Act allows for a coronavirus-related distribution to qualified participants anytime in 2020. In general, a qualified participant is someone who has been diagnosed with the coronavirus (or their spouse or dependent) or has been negatively impacted by being unable to work due to being laid off, quarantined, etc. Plan sponsors may rely on an employee’s certification that they meet the requirements.
These distributions can be as much as $100,000, but cannot exceed the vested balance of the account. The tax on the distribution can be spread over three years and the 10% penalty for those under 59-½ will be waived. Participants will also be allowed to “repay” the distribution over three years and thus avoid the tax altogether.
- The Act also makes changes with regard to plan loans to qualified participants (see definition above). The limits on such loans will be doubled to $100,000 from $50,000 and will be capped at 100% of the participant’s vested loan balance, rather than 50% under current provisions. These changes will apply to loans taken out in the six months following the enactment of CARES (i.e. up to September 23, 2020).
Additionally, participants may delay the repayments of these loans that would otherwise be due between the date of loan and December 31, 2020 for one year, thus extending the maximum repayment period to six years. Furthermore, qualified participants who had an existing loan may also take advantage of the delayed repayments, thereby extending the repayment period for their loans by one year.
These two provisions are optional. Plans that allow these provisions will require a retroactive plan amendment by the end of the 2022 plan year. Early indications are that volume submitter and prototype plan providers are adopting either an “opt-in” or opt-out” approach.
- Lastly, required minimum distributions (“RMDs”) from 401(k)s and IRAs, including inherited 401(k)s and IRAs, will be waived for 2020. This provision, unlike the two discussed above, is not intended to help individuals with immediate cash needs. Rather, those who can afford not to take the RMD won’t have to sell beaten down securities to fund the RMD, thus preserving their nest eggs and providing an opportunity to recover market losses.
Observations on These Provisions
“Desperate times call for desperate measures” seems to be an apt description of these provisions. For quite a while now, we’ve been bombarded with doom and gloom predictions about how Americans are woefully unprepared for retirement. The leakage issue is one of the factors cited for this problem. Leakage refers to how participants use plan features such as loans and hardship distributions to draw down their retirement accounts to fund current needs. The Act, however, makes it easier for a participant to withdraw an even greater amount from their account, thus increasing the leakage problem. It also seems to reinforce the attitude of many plan participants that the retirement account is like a piggy bank to be accessed whenever deemed necessary. Obviously, this attitude won’t help individuals become better prepared for retirement.
Without doubt, there are situations that individuals encounter where they desperately need cash, and the current coronavirus certainly could be one of those for some. It’s also true, however, that many will be tempted to access their account balance even if not entirely necessary. After all, it’s in our nature to give more weight to present needs (wants) than future needs such as money to live on once retired. In an ideal world, each individual would make the optimal decision, balancing current needs with future needs. Unfortunately, it’s not an ideal world. As a plan sponsor, though, you have the ability to help participants make better decisions. This can be done through financial wellness programs, education and appropriate communications. A good advisor can be instrumental in helping provide or arrange for these initiatives.
In the current coronavirus situation, the 401(k) plan is not likely high on the sponsor’s priority list, unless the reduction of employer contributions is being considered. However, it is at times like this that participant communication and education are the most beneficial. If your plan is going to adopt the coronavirus-related distribution and loan provisions, communications and education meetings about this should be considered. There should be a balance between explaining the new options and benefits, as well as the drawbacks. Even if your plan will not adopt these new provisions, in anticipation of increase loan and hardship distribution requests, it may be worthwhile to direct communications and hold meetings to go over the pros and cons of taking out loans or normal hardship distributions. For example, some of the downsides participants should be reminded of are:
- The negative impact on future retirement income
- Withdrawing funds in this down market will require selling securities at a low price point
- If the distribution is not “recontributed” within the three-year period, then the participant will owe tax on the distribution
- If a loan is taken, then the participant will need to repay it over a six-year period; however, if the employee is terminated or resigns in that period, the entire amount will likely need to be paid back at that time or else it will be deemed a taxable distribution
Clients of Shea Labagh Dobberstein should be hearing from their service providers about these matters. If you have any questions or comments, call or email Rich Baker. He can be reached at 415.869.5578 or firstname.lastname@example.org.