Preparing Qualified Plans for COVID-19-Related Needs

As a result of the economic uncertainty and business disruptions related to the COVID-19 pandemic, plan sponsors may be reviewing their qualified retirement plans to determine the types of financial assistance that may be available to affected employees or whether employer contributions under the plan can be eliminated or reduced to decrease business costs. Below are some items that plan sponsors may want to consider with respect to the use of their qualified retirement plans to meet these objectives as well as some consequences that may result from the economic impact of the pandemic.

In-Service Distributions from 401(k) and Profit Sharing Plans

In general, distributions from 401(k) and profit sharing plans are not permitted until a participant terminates employment. However, the law permits participants to obtain the following types of distributions while still employed.  

Attainment of Age 59-1/2. A 401(k) or profit sharing plan may permit in-service distributions upon a participant’s attainment of age 59-1/2. If not already included as a plan provision, the plan can be amended to add this in-service distribution. If the plan is a safe harbor 401(k) or 401(m) plan, certain notice and other requirements must be met if the amendment is adopted during a plan year. However, once added, rights to in-service distributions generally cannot be removed from the plan unless specifically limited in time or circumstances (subject to nondiscrimination rules) at the time they were initially added.

COVID-19-Related Distributions. The Coronavirus Aid, Relief and Economic Security Act (CARES Act), signed into law on March 27, 2020, allows for special distributions from 401(k) or profit sharing plans in order to help address the financial need of certain plan participants affected by COVID-19. Under the CARES Act, an individual may obtain special distributions from any eligible retirement plan if such individual (Qualified Individual):

i. is diagnosed with the virus SARS-CoV-2 or with COVID-19 by a test approved by the Centers for Disease Control and Prevention; 

ii. whose spouse or dependent (as defined in section 152 of the Internal Revenue Code of 1986) is diagnosed with the virus or disease by such a test; or 

iii. experiences adverse financial consequences as a result of being quarantined, furloughed or laid off or having work hours reduced due to the virus or disease, being unable to work due to lack of childcare because of the virus or disease, or closing or reducing hours of a business owned or operated by the individual due to the virus or disease or other factors determined by the Secretary of the Treasury. 

The aggregate amount of these special, COVID-19-related distributions that a Qualified Individual can obtain from all plans cannot exceed $100,000. The distributions are not subject to the 10 percent early withdrawal penalty otherwise applicable to distributions prior to attainment of age 59-1/2, and, unless the participant elects otherwise, income attributable to the distributions are includable in the participant’s income for federal income tax purposes ratably over a three-year period beginning in the year of the distribution. Such distributions may be rolled over to an eligible retirement plan in one or more contributions over the three-year period after the day the distributions are received. The favorable tax treatment and repayment provision are not limited to employees but also are available to Qualified Individuals who have terminated employment as well as alternate payees and other beneficiaries with a vested interest in an eligible retirement plan. Although an amendment to offer COVID-19-related distributions is not immediately required, safe harbor 401(k) or 401(m) plans may be required to meet certain notice and other requirements.  

Hardship Distributions. The rules relating to 401(k) plans permit certain plan participants to obtain hardship distributions in time of “immediate and heavy financial need.” Applicable regulations contain a safe harbor list of circumstances that constitute a deemed immediate and heavy financial need, including if, among other circumstances, the distribution is for expenses and losses (including lost income) incurred by a participant whose principal residence or principal place of employment is located in the designated disaster area on account of the federally declared disasters. As of April 6, President Donald Trump had approved disaster area declarations for most of the states and overseas territories, which means that distributions to most participants are likely deemed to be on account of a hardship if the plan is using the safe harbor list for hardship distributions. If a plan does not already contain a hardship withdrawal provision, the plan can be amended to provide for hardship distributions. In addition to using the safe harbor list, a plan sponsor might consider amending its plan to expand the circumstances under which a hardship is permitted to include a “facts and circumstances” standard that would apply to participants affected by COVID-19 and who may not be eligible for a COVID-19-related distribution or hardship distribution under the safe harbor list. If the plan is a safe harbor 401(k) or 401(m) plan, certain notice and other requirements may apply if an amendment is adopted during a plan year.  

Other In-Service Distributions. A 401(k) or profit sharing plan may permit participants to obtain distributions of profit sharing contributions and non-safe-harbor employer contributions that have remained in the plan for at least two years or that have been allocated to a participant who has participated in the plan for at least five years. If a plan does not already provide for these types of distributions, the plan can be amended to add these distributions. If the plan is a safe harbor 401(k) or 401(m) plan, certain notice and other requirements must be met if the amendment is adopted during a plan year. However, once added, rights to in-service distributions generally cannot be removed from the plan unless specifically limited in time or circumstances (subject to nondiscrimination rules) at the time they were initially added. 

Loans to Participants in 401(k) and Profit Sharing Plans

General Considerations. Another way for plan participants to obtain access to their 401(k) or profit sharing plan is through plan loans. If a plan does not already provide for loans, the plan sponsor could amend the plan to add plan loans. If the plan already provides for loans, the plan sponsor may wish to expand the availability of loans. For example, if the plan limits the number of loans outstanding, the plan sponsor can consider changing or removing this limit (subject to applicable limits on loan amounts). If the plan is a safe harbor 401(k) or 401(m) plan, certain notice and other requirements may apply if an amendment is adopted during a plan year.  

COVID-19-Related Loan Provisions. In addition to COVID-19-related distributions, the CARES Act includes special rules related to plan loans. Under the CARES Act, the limit applicable to plan loans taken by a Qualified Individual between March 27 and September 22, 2020, is increased to the lesser of 100 percent of the Qualified Individual’s vested account under the plan and $100,000 (instead of the normal loan limit of the lesser of 50 percent of the participant’s vested account and $50,000). Furthermore, for Qualified Individuals, if the due date of any of their plan loan repayments falls within the period beginning on March 27 and ending on December 31, 2020 (the Delayed Period), the due date for those repayments is delayed for one year. Payments that are otherwise due on January 1, 2021, and later are not delayed, so loan repayments will restart on January 1, 2021, even if loan repayments for the Delayed Period are paid at a later date. The period of delay is disregarded for purposes of the five-year maximum loan term applicable to loans other than home loans. Subsequent repayments will be appropriately adjusted to reflect the delay in the due date and any interest accrued during such delay.

In-Service Distributions From Defined Benefit Plans

In general, participants in defined benefit plans may not receive distributions prior to termination of employment or, if later, attainment of the participant’s “normal retirement age” under the plan (generally attainment of age 65). A new provision added by the Setting Every Community Up for Retirement Enhancement (SECURE Act), which became law on December 20, 2019, permits participants to receive in-service distributions from defined benefit plans after attainment of age 59-1/2. A plan sponsor could consider amending its plan to provide for this in-service distribution. However, once added, this provision generally cannot be removed unless limited in time or circumstances (subject to nondiscrimination rules) at the time it is initially added. In addition, such an amendment could negatively affect the cash flows, or funded status, of the plan. Therefore, the plan’s actuary should be consulted before this type of amendment is adopted.

Changing or Freezing Benefits

401(k) and Profit Sharing Plans. A plan that provides a matching contribution or other type of employer contribution generally may be amended to eliminate or reduce those contributions, but only to the extent the participants do not already have a right to the contribution. For example, a plan that requires an employee to be employed on the last day of the plan year in order to accrue a matching contribution generally may be amended during the plan year to eliminate or reduce that contribution.

However, if the plan is a safe harbor 401(k) or 401(m) plan, a midyear change to the matching contributions or other employer contributions under the plan may be made only if the change meets special legal requirements applicable to midyear changes to safe harbor plans. For example, an employer may suspend or reduce safe harbor contributions if the employer is operating at an economic loss for the plan year or if the annual safe harbor notice previously distributed to participants includes a statement indicating that the plan may be amended during the plan year to reduce or suspend safe harbor contributions. Other conditions have to be satisfied as well, including but not limited to providing supplemental notices to employees at least 30 days before such suspension or reduction becomes effective (or the date the amendment is adopted, if later) and providing employees with a reasonable opportunity to change deferral elections following receipt of such supplemental notice and before the amendment becomes effective.

Defined Benefit Plans. Benefits under a defined benefit plan cannot be frozen or reduced unless affected participants are provided with a written notice at least 45 days (15 days for plans with fewer than 100 participants) before the effective date of the amendment that freezes or reduces benefits under the plan. The written notice must contain certain information required by law.

Investment-Related Issues

401(k) and Profit Sharing Plans. Plan participants may be concerned about their plan investments due to the heightened market volatility and losses in the public markets. To address these issues, plan fiduciaries could consider providing, or having their plan administrator provide, investment education to help participants understand the financial markets and take appropriate actions based on their respective investment objectives.

Certain investment options offered under a 401(k) or profit sharing plan may have favorable fee arrangements tied to minimum plan investment thresholds. As a result of the losses in the public markets, a plan may no longer meet the minimum investment thresholds. Accordingly, plan fiduciaries should consider any higher fees in monitoring the fund.  

Defined Benefit Plans. The funding level of defined benefit plans could be negatively impacted by the losses in the public markets. Therefore, plan sponsors should determine whether these losses could require restrictions on the payment of lump sums or other benefit restrictions. The CARES Act permits a defined benefit plan sponsor to elect to treat a plan’s adjusted funding target attainment percentage (AFTAP) for the last plan year ending before January 1, 2020, as the plan’s AFTAP for plan years that include 2020 for purposes of determining whether any limits on benefits and benefit accruals under section 436 of the Internal Revenue Code apply. Accordingly, if this election is made, restrictions on payment of lump sums or other benefit restrictions may not be triggered due to the losses in the public markets. In addition, under the CARES Act, the payment of minimum funding contributions to single-employer defined benefit plans due in 2020, including quarterly installment payments, are delayed until January 1, 2021. The amount of such delayed minimum contributions will be increased by interest accrued for the period between the original due date and the new payment date. Fiduciaries of plans should consider how delayed contributions could affect the plan’s liquidity and whether any adjustments must be made to the plan’s investment strategy. 

Partial Plan Terminations

The layoff of a significant portion of employees could result in a partial termination of a qualified retirement plan. Employers need to be aware that if 20 percent or more of the participants in a plan are laid off, in general, the plan may be considered to be partially terminated. A partial termination generally requires full vesting of the benefits of participants who are less than fully vested.