Provisions in the Coronavirus Aid, Relief and Economic Security (CARES) Act don’t only apply to defined contribution (DC) plans; some apply to defined benefit (DB) plans as well. For example, DB plan sponsors may offer coronavirus-related distributions (CRDs) to participants, subject to certain plan and regulatory rules.
The provisions for CRDs contained in the relief bill apply to DB plans in the same way they do to DC plans, as long as pension plan sponsors had previously allowed for in-service distributions, says Brian Donohue, a partner at October Three in Chicago.
Participants in both types of plan qualify for a distribution if an individual was diagnosed with COVID-19, had a spouse or dependent who was, or experienced adverse financial consequences as a result of the COVID-19 crisis. Plan sponsors may rely on participant self-certification that the participant has been affected. “If employers are worried about employees claiming hardship, it’s not their responsibility to monitor that,” Donohue states.
Hitz Burton, partner for legal consulting and compliance at Aon, says DB plan sponsors can only provide coronavirus-related distributions to those otherwise eligible for a distribution under the Internal Revenue Code, such as a terminated, vested or retirement-eligible former employee, as long as the distribution is permitted by plan terms. Additionally, coronavirus-related distributions can be used in a DB plan that permits distributions at attainment at age 59 1/2 or older as a de-risking opportunity, he adds.
The CARES Act does not change when a distribution may be made to a DB participant, October Three explains in a post on its website. However, for other participants, including those “furloughed”—but not permanently “separated from employment”—active employees older than age 59 1/2 and retirees, the answer is more complicated. The firm recommends DB plan sponsors review these issues with counsel if they are interested in making 2020 lump-sum distributions to one or more of these groups. “We are going to need some guidance from the DOL [Department of Labor] in terms of model language, because that will need to be modified this year when it comes to these distributions,” Donohue says.
Since the CARES Act removed certain requirements, these new distributions are an attractive option for some, he adds. For example, while traditional in-service distributions are subject to a 10% early withdrawal tax, a CRD is not. Additionally, CRDs can be included in taxable income over a three-year period and may be recontributed to the plan during this period.
DB plan sponsors that consider adding a CRD option to their plans should be mindful about certain provisions. For example, the $100,000 limit on these distributions must be monitored and applied across qualified plans—both DB and DC—that are sponsored by the employer, Burton notes. “Because of the likely difficulty and associated compliance risk with monitoring the $100,000 limit across multiple plans, Aon generally recommends that a sponsor considering a CRD provision only do so for a single qualified plan within its controlled group,” he adds.
DB plan sponsors offering lump sums today, but not administering a CRD provision for 2020, also have an important disclosure point to consider, Burton warns. The information provided to participants in the current IRS safe harbor special tax notice has not been updated to describe important information regarding the tax-favored treatment available to qualified individuals affected by COVID-19. Under the CARES Act, for example, qualified individuals who receive an eligible rollover payment (e.g., lump sum) in 2020 can recognize the taxable income over a three-year period. “As a result, we believe that plan sponsors should consider providing all participants with additional information about how the CARES Act may impact the federal income taxes that they will owe,” he says.
Burton says Aon believes that CRDs in DB plans will be most prevalent in those plans that already offer lump-sum distributions—whether permanent or temporary—including cash balance and other hybrid pension plans. CRDs may also be offered as part of an early retirement or lump-sum window program in 2020.
Donohue notes that DB plan sponsors have long been crafting efforts to push participants to take lump sums instead of pension payments. Paying out lump sums reduces risk for the plan, and it reduces the overhead cost associated with Pension Benefit Guaranty Corporation (PBGC) premiums. Participants who may not have chosen a lump-sum distribution when the opportunity was offered to them before may do so now to reap the tax advantages of CRDs, he says.
But, in 2020, there’s a whole new set of reasons to move money out of pension plans, Donohue says. “Just how we’re seeing business loans and unemployment checks, everyone is just in this push to move money into the economy to continue the flow of things,” Donohue explains. “DB sponsors are looking at this opportunity to be a part of that, to try to provide lifelines to participants.”
« Emergency Savings Post-COVID Will Be Viewed Differently