3801 / What special rules governing retirement plan distributions were implemented for distributions related to the COVID-19 impact?

Editor’s Note: Many were confused about whether the Consolidated Appropriations Act of 2021 (the CAA) extended the tax relief for coronavirus-related distributions (CRDs) discussed below. The law did not extend the CARES Act CRD provisions into 2021. The law provided the same type of tax relief for non-COVID-19 disasters, such as wildfires and hurricanes. The CARES Act relief provided for qualified plan loans was also extended for victims of non-COVID-19 disasters. Additionally, RMDs were not suspended for 2021. 2021 RMDs were calculated using the year-end account balance just like any other year.

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) allowed taxpayers to take up to $100,000 in distributions from an employer-sponsored retirement plan (401(k), 403(b) or defined benefit plan) or an IRA without the distribution becoming subject to the 10 percent early distribution penalty (the 25 percent early distribution penalty that applies to early distributions from SIMPLE IRAs was also waived). Unless the participant elected otherwise, the coronavirus-related distribution (CRD) was included in income ratably over three years, beginning with the tax year of distribution.

The actual amount of the CRD did not need to be tied to the amount the participant requires to satisfy the COVID-19-related financial need. The amount was also a per-taxpayer rule, not a per-plan rule, meaning that distributions from all plans were considered when determining whether they qualified for favorable tax treatment.¹

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Planning Point: Plan sponsors had discretion as to whether they chose to implement any of the CARES Act relief provisions. However, the employee could elect favorable tax relief on a personal tax return regardless of whether the employer chose to implement these options.

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Note, however, that plans were not required to accept rollover contributions, which could create problems for participants in taking advantage of the three-year repayment option.

The CARES Act also provided repayment options to allow employees to repay CRDs during the three-year tax period beginning with the tax year of distribution (whether in a lump sum or installments over time). Although the repayment can be made to any type of plan that will accept the repayment, in which case it will be treated as a nontaxable rollover via direct transfer (and will not be counted as a rollover that would trigger the “one rollover per year rule”). Only distributions that qualify for penalty-free distribution relief (i.e., amounts up to $100,000) are eligible for repayment. Distributions paid to account beneficiaries (except for surviving spouses) are not eligible for recontribution (although these distributions can be treated as qualifying coronavirus-related distributions).²

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Planning Point: Employer-sponsored plans, however, are only able to accept rollovers from participants (and sometimes new hires). Therefore, if an employee took their entire account balance as a CRD and later stopped working for the employer, the person was no longer a participant or new hire. That former employee would, therefore, be required to re-contribute the funds to an IRA or to a plan sponsored by a new employer that accepts rollovers.

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When the employee took only part of the balance, employers should exercise more caution—because it’s unclear whether that former employee would continue to be treated as a plan participant. It’s important for the plan to have a non-discriminatory policy in place when deciding whether or not to accept these re-contributions (for example, by not accepting any rollovers from non-employees).

The penalty waiver was effective for distributions made on or after January 1, 2020 and before December 31, 2020.

The waiver was available for any “coronavirus affected individual,” which included both those who were diagnosed (or had a spouse diagnosed) with the virus and those who suffered financial consequences caused by layoffs, work reduction or being unable to work because of the need to provide child care.

Later IRS guidance expanded the list of qualifying individuals to include:

1. A plan participant whose pay was reduced due to COVID-19 (regardless of whether hours were reduced or whether the individual was laid off).


2. A plan participant who was planning to start a new job if the start date was pushed back (or the offer was rescinded entirely) due to COVID-19.


3. A plan participant whose spouse or member of the plan participant’s household suffered a qualifying effect.³

“Members of the participant’s household” included roommates or anyone who shared the participant’s primary residence. For example, if the participant’s live-in partner owned a business that was shut down due to COVID-19, the participant was eligible for the plan distribution
relief.

Employers could rely upon employees’ certifications that they satisfied conditions related to the hardship distribution unless the employer had actual knowledge to the contrary. The IRS provided a sample employee certification document in Notice 2020-50.

Similarly, plan loan rules were expanded to increase the available loan limit from $50,000 to $100,000 during the 180-day period beginning March 27, 2020. The due date for repaying loans taken before December 31, 2020 was delayed one year. RMDs for the 2020 tax year were waived.⁴