Coronavirus Aid, Relief and Economic Security (CARES) Act distributions up to $100,000 have been authorized by Congress through the end of the year, but they are not mandatory. Sponsors of tax qualified plans, 403(b) plans and governmental 457(b) plans can decide whether to allow them in 2020. Defined benefit (DB) and other pension plans may not make these distributions unless the participant is at least age 59 1/2. Individual retirement account (IRA) owners may also take CARES Act distributions from their IRAs.
If a plan allows special CARES Act distributions, only participants who are qualifying individuals who have been affected by COVID-19 will be eligible to receive them.
Eligibility. CARES Act distributions are available to individuals if they or their spouse or tax dependent has been diagnosed with COVID-19 using a test approved by the Centers for Disease Control and Prevention (CDC) or if they have experienced COVID-19-related adverse financial consequences as a result of being quarantined, furloughed or laid off or having work hours reduced, or as a result of being unable to work due to lack of child care, or the closing or cutback in hours of a business owned or run by them. CARES Act distributions may not be made if the spouse or dependent rather than the participant suffers the adverse financial consequences. In that event, the spouse would have to qualify under the spouse’s plan. Other criteria may be added by the Secretary of the Treasury, but none have been added so far.
Participants can self-certify that they have satisfied the requirements to receive CARES Act distributions.
These Distributions Get Special Federal Tax Treatment. CARES Act distributions are not treated as qualifying rollover distributions, so are not subject to mandatory 20% withholding, and they are also exempt from the 10% tax on distributions paid prior to age 59 1/2. Unlike regular distributions, which are taxable in the year of distribution to the extent they are not rolled over, federal tax liability for CARES Act distributions may be spread over the three-year period from 2020 to 2022. There is also a special right to recontribute all or part of a CARES Act distribution within three years of the date of the distribution to an eligible plan that accepts rollovers. This eliminates federal tax on the recontributed distribution.
Any distribution made to a qualified individual in 2020, even if it was made before the CARES Act was passed, may be designated as a CARES Act distribution by a qualified individual. It does not matter whether the plan specifically provides for CARES Act distributions and, in order to qualify, the qualified individual doesn’t have to provide proof of a specific loss caused by COVID-19. However, the total designated by a qualified individual for special tax treatment may not exceed $100,000.
Do Participants Have Alternatives? Yes, but they will not be entitled to the special tax treatment unless they are qualified individuals.
Many defined contribution (DC) plans already allow in-service distributions, including distributions to participants who are age 59 1/2 or older and immediate distributions to participants whose employment has terminated. All participants who satisfy the plan requirements will be eligible for these distributions.
Many defined contribution plans already provide for hardship distributions if participants satisfy IRS rules and cannot meet their financial need from other resources. Hardship distributions are permitted for specific events such as to prevent eviction from a principal residence or for certain losses due to federally declared disasters. IRA withdrawals may usually be made for any reason. Many plans—but not IRAs—also permit participants to borrow from their accounts.
Plan Sponsors Should Communicate with Participants. Plan sponsors need to let participants know if they have elected to make special CARES Act distributions available. It is also advisable to also give participants information about the right of qualified individuals to designate other distributions as eligible for the special tax benefits. In addition to distributing notices to participants, plan sponsors should make sure the information about distributions on their plan website is current. They may even want to have a dedicated hotline to respond to participant questions. Due to the complexity of the new rules, plan sponsors may also wish to have their ERISA [Employee Retirement Income Security Act] counsel review all communications before they are distributed or posted.
The CARES Act loan provisions will be the subject of the next column.
Carol Buckmann is a co-founding partner of Cohen & Buckmann P.C. As a highly regarded employee benefits and ERISA [Employee Retirement Income Security Act] attorney, Buckmann deals with the foremost issues in ERISA, including pension plan compliance, fiduciary responsibilities and investment fund formation.
She has 40 years of practice in this area of the law and a depth of experience on complex pension law and fiduciary problems. She regularly shares her thoughts on new developments in the benefits industry on Insights, Cohen & Buckmann’s blog, and writes and speaks on ERISA topics. Buckmann has been recognized by Martindale-Hubbell as an AV Pre-eminent Rated Lawyer, was selected for inclusion in the Best Lawyers in America and was named one of the Super Lawyers in Employee Benefits.This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.
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