May 21, 2020 Issue: Spring 2020

SECURE And CARES: Eight Interesting Issues Affecting Retirement Plans

By: Freeman Levinrad, Trucker Huss, APC

One of the most popular article formats around right now is the list - the internet is obsessed with them.  Lists are great because they draw the eye and tie otherwise seemingly disjointed ideas together. In that vein, please enjoy this list of eight interesting retirement plan issues about the Setting Every Community Up for Retirement Enhancement Act (the SECURE Act) and the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), both of which contain numerous provisions affecting retirement plan design and administration.

1. There are oversights in the CARES Act distribution relief.

The CARES Act provides considerable tax relief on early distributions to participants adversely affected by the COVID-19 pandemic. However, there appear to be oversights in the drafting preventing people who have undoubtedly been negatively impacted by the pandemic from qualifying for relief.

Under the CARES Act, qualifying distributions (called “Coronavirus-Related Distributions”) are exempt from the 10% early withdrawal penalty, can be taken into taxable income ratably over three years, and can be repaid within three years to an IRA or qualified plan that accepts the rollover. The CARES Act also created a new distributable event for 401(k), 403(b), and governmental 457(b) plans for these distributions.

To qualify for a Coronavirus-Related Distribution, a participant (or his or her spouse or dependent) must have been diagnosed with the coronavirus or COVID-19 disease by a test approved by the CDC, or the participant must have experienced “adverse financial consequences as a result of being quarantined, being furloughed or laid off or having work hours reduced due to such virus or disease, being unable to work due to lack of child care due to such virus or disease, closing or reducing hours of a business owned or operated by the individual due to such virus or disease, or other factors as determined by the Secretary of the Treasury (or the Secretary’s delegate).”

In a plain reading, many seemingly valid Coronavirus related reasons a participant may need a distribution would not qualify as a Coronavirus-Related Distribution.  For example:

  • A participant has adverse financial consequences because his or her spouse (as opposed to the participant) was quarantined, furloughed, or laid off as a result of the pandemic;  
  • A salaried participant’s wages are reduced without a reduction in hours.

The IRS and Treasury Department are currently in the process of reviewing public comments requesting that the list of covered factors be expanded.

2.  The CARES Act loan delay is an optional plan design feature.

The CARES Act provides that a “qualifying individual” (someone who meets the same requirements for a Coronavirus-Related Distribution”) may delay plan loan repayments that are due between March 27, 2020 and December 31, 2020 for a period of up to one year.

There was some debate in the retirement plan community about whether this one-year loan repayment delay under the CARES Act is optional or mandatory, with recordkeepers taking different positions on whether they are compelled to provide a delay to any qualifying participant who has an outstanding loan and requests one.

As the IRS hasn’t released formal guidance on this issue, it is reasonable to look to Notice 2005-92, where the IRS provided guidance on an almost-identically worded provision passed after Hurricane Katrina. There, the IRS took the position that the employer could decide whether or not to make the loan delay available to participants. Additionally, in Q&As published on the IRS’ website on May 4th, the IRS confirmed that the loan rules in Section 2202 of the CARES Act (which include the loan delay provision) are optional.

For certain employers, adding the loan delay could create administrative complications. For example, an employer that does not allow loans to be repaid by terminated employees through ACH may have to consider making that feature available for eligible terminated employees who request a delay if the employer wants to give those individuals the opportunity to avoid a default.

3.  The CARES Act does not create a new distributable event for money purchase plans.

Benefit attorneys working with money purchase plans have seen some inconsistent information circulating about the impact of the CARES Act provisions on money purchase pension plans.  Communications discussing the impact of the CARES Act on defined contribution plans generally are creating the false sense that CARES Act loan provisions apply to money purchase plans.  This is not the case. The CARES Act did not create an exception to Section 401(a)(36) of the Code, which restricts a money purchase plan from permitting in-service distributions before age 59½ (recently lowered from age 62). The only exception to this rule would be for the rare plan with a normal retirement age earlier than 59½, in which case distributions could be permitted upon normal retirement age. As such, a participant in a money purchase plan will only qualify for the tax relief provided to Coronavirus-Related Distributions if he or she receives a distribution that is otherwise permitted under the terms of the Plan (e.g., a hardship withdrawal or distribution due to termination of employment). Please note that the same restrictions apply to money purchase assets merged into profit-sharing/401(k) plans.

4. The change to the death benefit payout rules has a potentially significant impact on defined contributions plans that provide for annuity distribution options.

The SECURE Act eliminated the ability for a non-spouse beneficiary to receive distributions of death benefits under a defined contribution plan spread over his or her lifetime. Now, any death benefits must be distributed to such a beneficiary within ten years of the participant’s death unless the beneficiary is an “Eligible Designated Beneficiary,” which includes someone who is (i) the participant’s spouse, (ii) disabled, (ii) chronically ill, (iii) not more than 10 years younger than the participant, or (iv) a minor child (in this case, the benefit must be paid out within 10 years of the minor child reaching age 18). The determination of whether a beneficiary is an Eligible Designated Beneficiary is made at the time of the participant’s death. Notably, this rule applies whether or not a participant dies before required minimum distributions have commenced.  

This law change creates a significant issue for money purchase plans and profit-sharing plans that provide for annuity distribution options where a survivor annuity is payable to a former spouse or a non-spouse beneficiary (if the plan permits this). As an illustration, assume a scenario with a married participant in a money purchase plan who retires and elects to receive the normal form of distribution (a 50% qualified joint and survivor annuity), with his spouse as the beneficiary. After benefit commencement, the participant and spouse divorce. Under the terms of the Plan, this divorce does not affect the former spouse’s entitlement to the survivor annuity upon the participant’s death. The participant then dies. Under the terms of the Plan and the terms of the annuity contract, the former spouse is entitled to a survivor annuity. However, unless the former spouse meets one of other requirements to be an Eligible Designated Beneficiary as of the date of the participant’s death, the law now requires all of the benefits to be distributed within ten years. This creates a conflict where the IRS will hopefully provide additional guidance.

5. The new age 72 required beginning date under the SECURE Act is optional at the plan level.

The SECURE Act changed the required beginning date under Section 401(a)(9) of the Code (for employees other than five-percent owners) to April 1st of the calendar year following the later of the calendar year in which the participant (1) reaches age 72 (increased from age 70½) or (2) retires. This change is effective for any participant who turns 70½ after December 31, 2019 (i.e., anyone who was born after July 1, 1949).

This is not a required change. The required minimum distribution (RMD) rules only prescribe the latest date that distributions must commence from a qualified plan, but plans can require distributions to commence earlier and in fact, can force distributions without participant consent beginning as early as normal retirement age. As such, this change made by the SECURE Act would not generally cause a plan’s required commencement date to change unless the plan does not contain a provision requiring distributions to commence at a specific date and instead incorporates Code Section 401(a)(9) by reference for that purpose.

Plan sponsors should review the terms of their plan document to determine whether an amendment is required to change the required minimum distribution age under their plan as permitted under the SECURE Act, and if so, whether such a change is desirable.  

Plan sponsors should also keep in mind the different between when a plan requires distributions and when distributions are permitted. If a plan permits in-service distributions upon a certain age (for example, at age 70½) that is a protected feature and cannot be eliminated with respect to accrued benefits, even if the plan is amended to take advantage of the new age 72 required commencement date.

6. The 2020 RMD waiver is also optional at the plan level.

The CARES Act waives the requirement to take RMDs for 2020. However, plan sponsors are not required to change their regular distribution processes and could choose to continue requiring participants to receive payments that would otherwise be RMDs (in that case, the payment would be eligible for rollover by the participant).

For plans that do decide to waive the requirement to take distributions that would otherwise by RMDs for 2020, the relief could be implemented one of two ways: 1) a payment that would normally be an RMD will only be made if a participant requests the distribution, or 2) the payment will be made unless the participant opts out of receiving it.

7. Suspending 401(k) matching contributions mid-year may require a true-up.

While not specifically related to the CARES Act, given the trying economic circumstances resulting from COVID-19, many plan sponsors have been forced to consider reducing or suspending their 401(k) employer matching contributions mid-year. One issue to consider when going through this exercise is whether a “true-up” will be required based on the plan’s particular matching formula. For example, take a plan that approved matching contributions for the 2020 plan year based on a formula of 100% of deferrals, up to a maximum five percent of plan year compensation. In operation, matching contributions were funded each payroll period in an amount of up to 5% of payroll period compensation. The plan sponsor then amends the Plan to suspend the match effective May 1, 2020. While there is no formal guidance on whether a true-up is required in this scenario, a true-up applying compensation through the effective date of the amendment and taking into account deferrals made during the full plan year seems consistent with the spirit and intent of when participants accrue a right to benefits under a defined contribution plan.

8. Pay attention to plan governance when implementing CARES and SECURE.

Many recordkeepers are rolling out various provisions of the SECURE Act and CARES Act on an “opt-out” basis, where the provision is being implemented unless a plan sponsor affirmatively opts out. Plans sponsors should make sure that regular plan governance procedures regarding the approval of plan design changes is followed. For example, if a new distributable event for Coronavirus-Related Distributions is being added to a plan, the entity or individual with the authority to approve plan design changes should formally approve (or ratify, if appropriate) such a change. Of course, any changes that are implemented operationally will eventually need to be reflected through a conforming plan amendment.