Assurance News

CARES Act Loans and Distributions: Long-Term Impact On Retirement Savings

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The Coronavirus Aid, Relief and Economic Security (CARES) Act allowed plan sponsors to relax loan and distribution rules in 2020, giving participants greater access to funds during the pandemic. These provisions were implemented to provide relief as many employees do not have adequate short-term savings. Employee Benefit Research Institute (EBRI) has found that only one in five families has at least three months of liquid savings. Layoffs, furloughs and other circumstances caused by the pandemic have left many workers struggling financially, so naturally, many looked to their retirement accounts for relief. While this access has been a useful tool for many financially strained Americans, such loans and withdrawals could inflict long-term damage on their progress toward a successful retirement.
 
Employers have an important role to play in helping to ensure that the flexibility offered by the CARES Act is used to alleviate workers’ short-term financial strains while minimizing the impact on their overall retirement strategy. Employers can do their part by carefully communicating how these withdrawals affect the amount that will be available to use in retirement and providing resources to assist in developing strategies to recuperate those funds.
 

CARES Act Allows for Loans and Coronavirus-Related Distributions

Under the CARES Act, plan sponsors had the option to allow participants to take advantage of increased loans with delayed repayments or coronavirus-related distributions (CRDs) without an early withdrawal penalty. Participants are allowed – but not required – to pay back the distributions within three years. During 2020, employers determined whether they would allow those provisions to be adopted within their plans, and if so, the amounts in which employees could take.
 
Research from the Plan Sponsor Council of America (PSCA) found in the 4th quarter of 2020, 54% of plan sponsors adopted the provision to allow CRDs while 31% permitted an increase to the plan loan limit. When offered both the option of loans and CRDs under the CARES provisions, 54% of participants selected a CRD which would not require a repayment.
 
According to Vanguard, as of the end of 2020, only 5.7% of the participants offered the option to withdraw assets initiated a CRD. While the percentage of participants who selected this option is relatively low and is less than initially projected, the average distribution represented 55% of the participant’s total balance with one in four distributions accounting for nearly 100% of their account balance. These participants may now face hardship in beginning their retirement savings accounts back at square one.
 

Communicate Long-Term Impact in Real Terms

Plan sponsors who did adopt these provisions should help participants understand that loans and distributions from defined contribution plans can negatively affect retirement savings and help them build a strategy around getting back to where they were. Participants have a lot on their minds today; in addition to navigating the pandemic and work and childcare routines, many are also wrestling with financial issues like healthcare bills or mortgage payments. Providing educational resources can help show participants how they can rebuild savings and get back on track for retirement – including tangible examples of repayment schedules.
 
The Employee Benefit Research Institute (EBRI) created projections to show the impact of taking CRDs on employees’ retirement balances for various age groups. These projections assume that employees take the full $100,000 distribution (or their full vested amount if it is less than $100,000). The projections show how much an employee’s retirement account balance at age 65 is projected to decrease as a multiple of the employee’s projected annual compensation at age 65.
 
In one scenario projected by the EBRI, employees take the full CRD and pay it back over three years. EBRI found that doing so caused account balances upon reaching age 65 to decrease a median of 2.3 percent across all age groups. But the negative impact was more than twice as significant (5.8 percent) for employees who took the distribution between the ages 60 and 64.
 
In another scenario, employees take the full CRD but do not pay it back. EBRI found that doing so caused account balances upon reaching age 65 to decrease a median of 20 percent for all age groups. But the negative impact was a staggering 45 percent for employees between the ages of 60 and 64.
 

Insight: Help Participants See the Impact

Based on the PSCA research, as of November 2020, only 38% of organizations had communicated the impact of these loans and distributions to plan participants. Plan sponsors can help their employees by providing straightforward information about how accessing the funds now can affect their financial futures. This information should include reminding participants that the repayment of these CRDs within the three-year time period will allow participants to avoid paying income taxes on the related distributions.
 
Although participants may not have the resources to currently increase their deferral rate to help make up the funds distributed as the pandemic is ongoing, plan sponsors should continue to encourage those who took CRDs to set a plan to increase their contributions in the future. Once financially stable, these participants can benefit from putting a plan in action to increase their contributions to make up for the funds and related investment earnings lost during this time period.

Relief For 2020 RMD Waivers and Rollovers Extended By IRS

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The Coronavirus Aid, Relief, and Economic Security (CARES) Act, enacted on March 27, 2020, waived required minimum distributions (RMDs) from tax-qualified defined contribution retirement plans (such as 401(k) and 403(b) plans) and individual retirement accounts (IRAs) that were otherwise due in 2020 to help Americans cope with the uncertainty caused by the COVID-19 pandemic. This was welcome relief for those who wanted to skip RMDs for the year, but the law created many unanswered questions—especially for those who had taken distributions before the law’s enactment. This relief does not apply to RMDs from defined benefit plans.
 
The Internal Revenue Service (IRS) issued guidance in late-June to clarify these issues and ensure that anyone who received an RMD in 2020 from a defined contribution plan or IRA can now roll the funds back into a similar plan. Most notably, IRS Notice 2020-51 extends the deadline for participants to return an unwanted RMD to their retirement accounts to August 31, 2020 (or 60 days after the distribution, whichever is later). The notice also expands the RMD waiver and rollover opportunity to owners of non-spousal inherited IRAs.

Key Elements of Notice 2020-51

The recent IRS notice contains five key provisions affecting plan sponsors and individuals who wish to skip RMDs in 2020 or roll previously taken 2020 RMDs back into their retirement accounts:

  • Individuals now have until August 31, 2020 to roll 2020 RMDs back into their retirement accounts; before Notice 2020-51, the deadline had been July 15, 2020.
  • The RMD waiver now applies to non-spousal inherited IRAs; previously, these accounts had been excluded from the waiver.
  • The usual limit of one rollover per year from IRAs does not apply to 2020 RMDs.
  • 2020 RMDs can go back to the plan they were taken from, as long as the plan allows it.
  • Plan sponsors (but not IRA vendors) will need to amend plans to reflect changes related to 2020 RMDs and rollovers; to help plan sponsors with this, the notice provides a two-part sample amendment that covers 1) giving participants the option of whether to take 2020 RMDs and 2) three options related to making direct rollovers available.

In addition, the notice includes a Q&A section that addresses several common issues related to the relief for RMDs and rollovers. In particular, the guidance specifies that plan sponsors do not have to accept rollovers and that the RMD waiver does not change an individual’s required beginning date to take RMDs—it only provides flexibility if RMDs started in 2020 (including 2019 initial RMDs that were allowed to be taken before April 1, 2020).

IRS Expands RMD Relief, but Deadline is Approaching
 
While the expansion of the RMD waiver coverage and the extension of the rollover deadline to August 31, 2020 is good news for many, the deadline is fast approaching. Plan sponsors need to act swiftly to see whether their plan allows rollovers of RMDs back into the plan. Those who wish to amend their plan to allow such rollovers should consider using the sample amendment provided in the notice or modify it to fit their plan’s circumstances.

Company Retirement Plans May Be Affected By Furloughs And Layoffs

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The coronavirus pandemic has forced many employers to implement some form of workforce reduction to continue operating. While furloughs and layoffs have a significant and immediate impact on a company’s operations, plan sponsors also need to understand the longer-term effects workforce reductions have on participants’ benefits and retirement accounts.
 
Over the next several months, employers should be mindful of their ongoing obligations and responsibilities as benefit plan sponsors.

Furloughs vs. Layoffs

First, it’s important to understand the varying impacts of a furlough versus a layoff. A furloughed employee (one who is considered on unpaid temporary leave of service, with the expectation that they will eventually return to work) may continue to receive some or all of their benefits during their time away, including healthcare and retirement benefits. However, because furloughed employees aren’t receiving a paycheck, they won’t continue to contribute to their 401(k). Employers may decide to make non-elective plan contributions for furloughed employees — although many companies may find this difficult to do considering the current economic uncertainty.  
 
By contrast, laid-off (terminated) employees who are no longer part of the company are not considered active members of a company’s retirement plan and therefore are unable to contribute to it. In general, laid-off employees can leave their 401(k) assets in the plan, cash out, or roll assets into another plan or individual retirement account (IRA).
 

Loans and Withdrawals During a Furlough

Plan sponsors should first reference their plan document to understand what existing guidelines they have in place regarding employment status and loans and withdrawals. If the plan allows in-service loans and withdrawals, these options may be available to furloughed employees who meet the plan’s qualifications. The Coronavirus Aid, Relief, and Economic Security (CARES) Act gives employers the ability to allow qualifying participants (including furloughed employees) access to the lesser of $100,000 or 100 percent of their vested account balance. As always, plan documents can be amended to change the way loans operate.
 

Loan Repayments for Furloughed Employees

The CARES Act allows – but does not require – employers to extend current qualified plan loan repayments by up to 12 months; this provision applies to loans to furloughed employees, as well.
 
Depending upon the terms of each plan, employees whose loans aren’t related to the virus may be required to repay their loans sooner if they are laid off. In addition, if the loan isn’t paid back on time, the participant’s loan balance will be considered in default and will become a taxable distribution.
 

Vesting Issues for Furloughed Employees

Some plans have vesting requirements that employees need to reach to have complete ownership of company matching contributions. Employers can define vesting in various ways, including based on a specific duration of time of employment or hours of service; however the maximum timeframe to vest is six years of full-time service.
 
A furlough may affect an employee’s vesting schedule as well. For plans that base vesting on hours of service, furloughed employees aren’t able to make progress toward such thresholds during a furlough because they are no longer working. For example, employees who need to have 1,000 hours of service to get to the next vesting level might not achieve that goal in 2020, depending on the length of the furlough. On the other hand, a duration of time vesting requirement isn’t affected by furloughs because these requirements are tied to when the employee starts and stops employment; the furlough time period counts toward this service requirement.
 

Insight: Plan Ahead and Communicate

 Plan sponsors whose organizations leveraged furloughs or layoffs to help stabilize from an immediate cashflow perspective need to understand the implications of these decisions to ensure that the company meets its obligations to plan participants.
 
Clear and timely communication with plan participants is very important in this environment. Employers should be proactive in ensuring that they can reach employees on a consistent basis; this includes confirming that they have proper contact information for employees on file before and during reductions in force. Employers should also work with service providers to understand how they may help in tracking and communicating with plan participants.
 
Plan sponsors should consult with their plan advisors and benefits professionals to understand the retirement plan implications of furloughs and layoffs and meet obligations to employees after these weighty decisions are made.