New coronavirus law allows new 401(k) distributions and loans

published in McAfee & Taft LINC Alert | March 27, 2020

This afternoon, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act is intended to provide relief to individuals and businesses that are impacted by the coronavirus public health emergency.

In addition to the numerous financial incentives provided to individuals and businesses, the CARES Act allows certain qualified retirement plan participants, including 401(k) plan participants, to take new distributions and plan loans from their plan accounts.

New distributions – Up to $100,000

The CARES Act allows certain 401(k) plan participants to take a coronavirus-related distribution from their retirement plan account up to $100,000. These distributions have significant tax advantages that do not currently exist, including: (1) the normal 20% federal income tax withholding can be ignored; (2) these distributions are exempt from the 10% early withdrawal penalty (that typically applies if a participant is under age 59.5); (3) the distribution can be repaid to the plan within three years and gain tax-free rollover treatment (without regard to typical plan limits); and (4) the individual can recognize personal income for the related taxes over a three-year period that begins when they take the distribution (as opposed to having all of the amount included immediately in their income).

Importantly, only certain individuals qualify for these distributions. Qualifying plan participants include participants (or their spouses or dependents) who (1) have been diagnosed with the virus SARS-Co-V-2 or with coronavirus disease 2019 (COVID-19); or (2) experience adverse financial consequences as a result of being quarantined, furloughed or laid off, having work hours reduced due to such virus or disease, being unable to work due to lack of child care as a result of the virus or disease, the closing or reduction of hours of a business owned or operated by the individual due to such virus or disease, or other factors as determined by the Treasury Secretary.

We are studying and digesting the CARES Act provisions quickly, but here are a few important details:

  • Any such distribution must be processed and distributed by December 31, 2020;
  • All contribution sources (e.g., 401(k) deferrals and employer matching contributions) are generally available for these distributions;
  • These distributions are subject to income tax withholding at 10% unless the participant elects a different percentage;
  • Plan documents will ultimately need to be amended to reflect this distribution but most plans will likely have until December 31, 2022 to accomplish this;
  • The plan administrator can rely on an employee’s certification that the employee is eligible for the distribution (see above); and
  • It appears employer plan sponsors can choose not to allow these distributions.

Increased 401(k) plan loans

The CARES Act also allows qualifying 401(k) plan participants to borrow a higher amount than what is normally allowed. During the 180-day period that started on March 27, 2020, the same qualifying individuals identified above (who are eligible for a coronavirus-related distribution) are generally eligible to borrow up to the lesser of:

  • $100,000 (which is double the normal limit); or
  • 100% of their vested account balance (double the normal limit).

The Act also allows more flexibility for repayment of these loans. Generally, participants can be allowed to delay repayment by up to one year.   

As with the new coronavirus-related distributions, plans will ultimately need to be amended to reflect this new loan option. Also, it appears employer plan sponsors have the option to decide whether to allow these new increased loans.

Waiver of 2020 required minimum distributions

Under current law, individuals who reach age 70½ prior to 2020 or 72 in 2020 (or a later year) must begin to receive “required minimum distributions” (RMDs) from the plan.

The CARES Act allows plans to suspend the RMD payments otherwise required to be made in calendar year 2020. The waiver applies to qualified retirement plans, defined contribution plans under Internal Revenue Code Section 403(a) or 403(b), and eligible deferred compensation plans under Internal Revenue Code Section 457(b) (excluding those maintained by tax-exempt entities).