Cure Periods and Other Ways to Prevent Leakage From Coronavirus Relief Bill

Coupling more generous loan programs with robust educational resources is a good place to start.

The Coronavirus Aid, Relief and Economic Security (CARES) Act gives retirement plan sponsors options to permit their workers to borrow more money from their plans and to extend the period in which the repayments are due. Attorneys believe many sponsors will embrace these options during this time of the coronavirus to help ease the financial burdens many of their workers are facing right now.

But “IRS regulations specify that if the loan repayments are not made according to the repayment schedule, the entire outstanding balance of the loan is treated as a taxable distribution and reported on Form 1099-R,” says Jana Steele, senior vice president at Callan, in a blog post. “Deemed distributions are subject to income tax and may be subject to the 10% early distribution tax.”

To relieve participants of this fate, Steele suggests that plan sponsors offer participants a “cure period” in which a missed payment may be made up to prevent the deemed distribution. “The cure period cannot continue beyond the last day of the calendar quarter following the quarter in which the required payment was due,” Steele says.

She adds that for participants who are not terminated but also not receiving a paycheck or enough income to make loan repayments, plan sponsors can offer automated clearing house (ACH) repayment options.

Additionally, while the entire balance of a loan is generally due upon termination from a company—and if it is not paid back, the loan goes into default—Steele suggests sponsors allow these terminated participants with loans to continue paying them.

While regular loan rules permit people to take out a loan for as much as $50,000 or 50% of their balance, between March 27 and the end of the year, the coronavirus relief bill extends that to $100,000 or 100% of their vested balance, says Paula Lewis, senior vice president at CBIZ Retirement Plan Service.

“We have clients who currently do not permit loans but now want to amend their plan documents to allow this,” Lewis says. “Some just want to allow it through the end of the year, while others want to make it permanent.”

For those affected by the coronavirus, sponsors can suspend loan repayments for the rest of the year without the loan going into default, Lewis adds. In addition to all these measures, some of Lewis’ clients that have a cap on the number of loans permissible in their plan are looking to extend that cap.

Jonathan Barber, senior vice president for compensation and benefits policy research at Ayco, says that his firm “likes the flexibility of these loans to be available to employees, but you have to couple that with education.”

“Make sure people understand the rules,” he emphasizes. “Under the CARES Act, if you have contracted the virus or have been financially adversely affected due to reduced work hours, being unable to work or furlough, you can take a taxable distribution up to $100,000 not subject to the 10% early withdrawal penalty that will be taxed pro rata over a three-year period.”

If and when the participant gets back on their feet, they can repay the distribution over that same three-year period.

“But, you are relying on the participant to get that done,” Barber warns. “With a loan, the repayments are structured by the plan. Sponsors have the option to offer one or the other option, both or none. We want to see both because of the flexibility.”