CARES Act—Optional or Required?: Part 1—Distributions

A common question regarding the CARES Act distribution, loan and required minimum distribution (RMD) waiver provisions[i] is whether these provisions are optional or mandatory. In most cases, they are optional—but in the retirement world there are very few questions where a short answer will suffice. 

There are two aspects to COVID-19 distributions (referred to in the Coronavirus Aid, Relief, and Economic Security Act as Coronavirus-related distributions). First, is a plan required to permit a COVID-19 distribution (i.e., is it a distributable event under the plan). Second, if it is optional for a plan, does that impact whether a participant can treat a distribution made for another reason as a COVID-19 distribution (no 10% additional tax for early distributions, taxation can be spread over 3 years; and the ability to repay distributions over 3 years). 

A plan sponsor is not required to permit a distribution to a qualifying individual.

One area of confusion, however, relates to which plans can permit these distributions. Technically, all ERISA-qualified plans, §403(b) arrangements, and §457(b) plans may permit them. However, pension plans (defined benefit and money purchase pension plans) have more limitations with respect to the distributions. This is because non-pension plans (e.g., §401(k) plans) can permit distributions upon the occurrence of an event such as a hardship or an individual being affected by the COVID-19 pandemic.

In fact, the CARES Act specifically provides an exception for elective deferrals, qualified nonelective contributions, qualified matching contributions, and ADP test safe harbor contributions. These amounts are subject to additional restrictions where they generally cannot be distributed to active employees prior to age 59½ or unless they have a financial hardship. However, the CARES Act does not provide an exception for the distribution restrictions that apply to pension plans. This means a COVID-19 distribution can only be made from a pension plan if the individual would otherwise have a permissible distributable event. For example, suppose a cash balance plan only permits distributions upon attainment of normal retirement age. The plan could provide for COVID-19 distributions to participants who are age 59½ (the earliest in-service distribution age that could apply to a pension plan). 

An individual’s ability to treat a distribution as a COVID-19 distribution is not dependent on how a plan treats the distribution. Under the CARES Act, an individual has received a COVID-19 distribution if: (1) the individual is an eligible individual (see below); and (2) the distribution was received between Jan. 1, 2020, and Dec. 31, 2020. There are some exceptions for corrective distributions (e.g., failing nondiscrimination tests). But other than that, it really is that simple. 

Let’s look at a situation where an RMD was made in January 2020 before we knew (under the CARES Act) no RMDs were required for 2020. That RMD could be a COVID-19 distribution if it’s made to an eligible individual (remember this could apply if the individual’s spouse or dependent was diagnosed with the virus). Now let’s assume the same participant was laid-off in March 2020 due to a COVID-19 related downturn in business and received a distribution under the plan’s termination of employment distribution provisions. This would also be a COVID-19 distribution. And, what if that same participant has a loan that was defaulted and offset against his or her account? You guessed it—another COVID-19 distribution. 

As it turns out, this is true even if the plan sponsor didn’t elect to permit a COVID-19 distribution (remember that the distribution provisions, like the expanded loan provisions, are optional). Assume that same plan sponsor then reported the distribution on the 1099-R as being taxable (assuming pre-tax dollars were distributed) with no known exception to the additional 10% tax for early distributions. How does that work? First off, the plan has to allow for the distribution—and if not the COVID-19 type, then a type of distribution (say, a hardship) that would apply. 

However, the tax treatment of a COVID-19 distribution is an individual issue, not a plan issue. It is handled as part of the individual’s income tax return and it doesn’t matter how the plan reported the distribution. This is not unusual—think about 60-day rollovers where the plan reporting is not determinative of whether an individual ultimately owes taxes on the distribution. The same applies here—and the individual would also be electing whether to pay any taxes over a 3-year period. 

If a plan permits a COVID-19 distribution, is it also required to accept a participant repayment? Most plans would probably want to accept the repayment. But if a plan didn’t want to accept the repayment, it appears that the plan would not be required to accept it. Note that this differs from the language on repayments for a qualified birth or adoption distribution (as permitted under the SECURE Act) where the legislative intent is that the distributing plan must accept repayments from active participants. 

The government agencies are working hard to provide additional relief and guidance on the CARES Act. Likewise, the American Retirement Association (ARA) Government Affairs team is continuing to stay in the forefront of providing input on regulatory and legislative initiatives. We will continue to keep you informed of future developments. 

Robert M. Richter, J.D., LL.M, is the American Retirement Association’s Retirement Education Counsel. He is the editor of the ERISA Outline Book.