IRS Issues Further Guidance on 401(k) Withdrawals, While Participants Hold Steady

Hardship withdrawals are less restrictive, but should be a last resort

Stephen Miller, CEBS By Stephen Miller, CEBS July 10, 2020
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The IRS recently issued additional guidance on the eased rules for hardship withdrawals that 401(k) and similar defined contribution retirement plans can put in place under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, enacted in March. New data show, however, that an expected surge in plan withdrawals hasn't happened.

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Coronavirus and COVID-19

New Guidance

Through the end of 2020, the CARES Act allows a new type of hardship withdrawal for participants in 401(k)-type plans or individual retirement accounts (IRAs) who are affected by COVID-19. Coronavirus-related distributions (CRDs) are not subject to the 10 percent early-distribution penalty and may be repaid over three years. Distributions may not exceed $100,000 per eligible participant.

Income taxes will still be owed on withdrawn amounts, but the law also lets individuals pay taxes on CRD income over a three-year period. Those repayments are not be subject to annual retirement plan contribution limits.

IRS Notice 2020-50, issued on June 19, "largely formalizes guidance the IRS set forth in a series of questions and answers in May," according to law firm Ice Miller. The notice expands the categories of individuals who are eligible for CRDs under the CARES Act to include, among other examples, those who experience adverse financial consequences as a result of:

  • A reduction in pay due to COVID-19 or having a job offer rescinded or start date for a job delayed due to COVID-19.
  • A spouse or a member of the individual's household being quarantined, furloughed or laid off, or having work hours reduced due to COVID-19, or being unable to work due to lack of child care due to COVID-19.

Robert Toth, principal at Toth Law and Toth Consulting in Fort Wayne, Ind., wrote that Notice 2020-50 "also made it clear that the employer cannot prevent the participant from claiming CRD tax treatment on (most) distributions the participant otherwise does take during the relief period, even where the employer has chosen not to 'opt' for CRD relief."

IRS Notice 2020-51, issued June 23, among its provisions:

  • Provides guidance on the waiver of 2020 required minimum distributions (RMDs) under the CARES Act, which suspended RMDs for defined contribution plans and IRAs for calendar year 2020.
  • Includes a sample plan amendment that plan sponsors can adopt to implement the 2020 RMD waiver. Plans should be amended by the last day of the plan year beginning on or after Jan. 1, 2022.
  • Extends to Aug. 31, 2020, the 60-day deadline to roll over funds to another qualified retirement plan as a result of RMDs already made in 2020 that were subsequently not required under the CARES Act.

In light of the new IRS notices, "Participant communications should be prepared and distributed to properly inform participants of any [retirement plan] operational changes…and any additional steps that participants will have to take in order to take advantage of any such changes," advised Gary Kushner, president and CEO of Kushner & Co., an advisory firm based in Portage, Mich.

[SHRM members-only HR Q&A: How Does the Families First Coronavirus Response Act (H.R. 6201) Impact Employers?]

No Withdrawal Surge

A wave of distributions from retirement plans never materialized, based on data from leading investment firms that provide 401(k) management services, blogged Michael Webb, vice president at New York City-based advisory firm Cammack Retirement Group. He called the findings "the CARES Act 'run on the bank' that wasn't."

For plans administered by Vanguard Investments, in April "less than 1 percent of participants initiated a CARES Act coronavirus-related distribution," he noted. "The data from other recordkeepers told a similar tale: from late March through May 8, only 1.5 percent of Fidelity participants accessed their funds, and at Empower, the figure was only 1 percent through May 31."

These numbers, Webb pointed out, "are in spite of the fact that the CARES Act made it easier and less expensive (from a tax perspective) to take a distribution."

As to why the crisis hasn't sparked more people to withdraw funds, "Maybe participants heeded the warnings about taking these distributions," Webb wrote. "Or perhaps, by the time they were ready to take a distribution, after various CARES Act stimulus programs kicked in, their financial situations sufficiently improved and they no longer needed the money. Or maybe people were simply not paying attention to the new liberal rules."

"Withdrawals turn 'paper' losses into actual losses," Webb warned in April. "If an investor still owns the underlying investments, and those investments increase in value in the future—as they typically do after a bear market—then the loss wasn't actually a loss at all. However, once a withdrawal is taken, the loss is locked in and can no longer be recovered."

Employees at small businesses may have felt more of the brunt of the economic shutdown, resulting in increased plan withdrawals, other research suggests.

Financial services firm Ascensus analyzed plans in its client database with fewer than 500 participants to explore how temporary business closures, employment changes, and falling incomes affected U.S. small-business owners and employees.

Between the beginning of March and the end of May, hardship withdrawals were taken from small-business retirement plan accounts at 2.5 times their normal rate, according to the report. However, 93 percent of retirement savers at small organizations made no change to their savings rates, which the report says illustrates the positive value of automatic payroll deduction.

Guidance on Halting Safe Harbor Matching Contributions

On June 29, the IRS issued Notice 2020-52, which provides temporary relief to plan sponsors that amend their safe harbor 401(k) or 403(b) plans midyear to reduce or suspend employer safe harbor matching or nonelective contributions due to the COVID-19 pandemic.

The notice includes relief from the 30-day advance supplemental notice requirement for suspension of safe harbor nonelective contributions (but not for suspension of safe harbor matching contributions) provided the supplemental notice is provided no later than Aug. 31, 2020.

Also, plans amended from March 13 to Aug. 31, 2020, to reduce safe harbor contributions, will be deemed to have satisfied the threshold "operating at an economic loss for the year" requirements for any midyear suspension of safe harbor contributions.

Separately, Notice 2020-52 clarifies that because contributions made on behalf of highly compensated employees (HCEs) are not included in the definition of safe harbor contributions, a midyear change that reduces only the contributions of HCEs is not considered a suspension or reduction of safe harbor contributions that requires an employer to meet certain requirements.

"Many employers have implemented or are considering changes to their 401(k) plan matching and nonelective contributions in light of the economic situation related to the COVID-19 pandemic," noted Steven Weinstein, a partner at law firm Proskauer in New York City. "There are a number of considerations with any of these changes, and employers should consider them carefully with counsel."

Between the beginning of March and the end of May, more than one in nine small U.S. employers—11.8 percent—reduced or stopped their retirement plan contributions, according to the Ascensus report.



Related SHRM Articles:

IRS FAQs Clarify Coronavirus-Related Retirement Plan Relief, SHRM Online, May 2020

How the CARES Act Changes Health, Retirement and Student Loan Benefits, SHRM Online, March 2020

Help Panicking 401(k) Participants Stay the Course, SHRM Online, March 2020

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