Did you know that the CARES Act increased the maximum loan amounts and provided for special distributions for certain qualified retirement plan participants who were impacted by COVID-19?

The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) is an economic stimulus bill passed on March 27, 2020 in response to the economic downturn caused by the coronavirus pandemic. The CARES Act provides relief similar to that which was provided during past natural disasters and economic crises (e.g., post Hurricane Katrina).  Among other benefits, the CARES Act makes it easier for individuals to access their savings in workplace retirement plans if those individuals were affected by COVID-19. 

Who is Eligible? 

The relief provided by the CARES Act is applicable to most qualified retirement plans, such as 401(k) plans, profit sharing plans, etc.  Additionally, the class of employees eligible for the expanded distribution and loan provisions (“qualified individuals”) is broad and includes many individuals who were impacted by COVID-19.  Specifically, employees who have been diagnosed with COVID-19 or who have had a spouse or dependent diagnosed would be considered qualified individuals under the CARES Act.  Additionally, employees who experienced adverse financial consequences due to COVID-19 (as a result of being quarantined, furloughed or laid off, unable to work due to lack of child care, business closure, or certain other factors) are also considered qualified individuals.  Luckily for employers, employee self-certification is acceptable to determine eligibility.

Changes to Distribution & Loan Provisions 

Under normal circumstances, plans may allow participants to take a loan from their account in an amount not greater than 50% of their vested balance, and in no circumstances greater than $50,000.  Additionally, plans may also generally allow participants to take hardship distributions from their accounts in the event that they have an immediate and heavy financial need, assuming the terms of the plan allow for such distributions.  

If an employee fell within the definition of a “qualified individual”, the CARES Act increased the limit on permissible plan loans and extended the repayment period. The increased limit is the lesser of $100,000 or 100% of the participant’s vested account for loans taken by qualified individuals from March 27, 2020 through September 22, 2020. Furthermore, the CARES Act allowed for a qualified individual’s loan repayments due between March 27, 2020 and December 31, 2020 for both new and existing loans to be suspended through December 31, 2020.  The term of such loans could be extended by up to one year, but loan payments were required to resume as of January 2021.  

Additionally, under the CARES Act, qualified individuals may treat distributions (up to a maximum combined amount of $100,000) made between January 1, 2020 to December 31, 2020 as coronavirus-related distributions.  These distributions include tax-favorable provisions, such as the ability for participants to spread out the time period during which the amounts are included in income over three years and an exception to the normal 10% early withdrawal tax.  The CARES Act also provides for a three-year rollover period for coronavirus-related distributions.  This provision allows participants to avoid taxation on any distributed amounts repaid within three years of the distribution date by treating the repayments as eligible rollover contributions. 

The IRS clarified in June 2020 that employers can choose whether to enact these distribution and loan provisions. Plan sponsors will have until the last day of the plan year beginning on or after January 1, 2022 (December 31, 2022 for calendar year plans) to enact the required amendments. 

What to Look for? 

In light of the complexity and short window for the expanded loan and distribution provisions available to qualified individuals, it may have been challenging for plan sponsors to develop sufficient processes and controls to ensure that these changes were implemented properly.  As a result, loans and distributions made in 2020 should be reviewed carefully for potential errors.  For example, confusion between the temporary suspension of loan repayments due between March 27, 2020 to December 31, 2020 and the one-year extension of the overall loan term may result in administration errors or even improper loan defaults.  

Given the relatively long lifespan of participant loans and certain distribution provisions provided in the CARES Act, coronavirus-related loans and distributions should continue to be monitored in future years as well.  For example, distribution repayments for coronavirus-related distributions could be received until the end of 2023 and could result in taxation errors if not tracked properly. 

As the pandemic has continued, the IRS has issued additional guidance and updates related to the provisions of the CARES Act.  Practitioners should ensure that they are up-to-date on the latest guidance to avoid operational errors while they are navigating these new provisions.

Assistance from Alvarez & Marsal

The compensation and benefits professionals at Alvarez & Marsal Taxand, LLC are uniquely qualified to assist you in complying with the CARES Act distribution and loan provisions. For more information, please contact our dedicated qualified plan team.