Jeffrey Banish, Partner, Troutman Sanders
Mamta Shah, Partner, Troutman Sanders
Karen Shriver, Associate, Troutman Sanders
Rebecca Alperin, Of Counsel, Pepper Hamilton
Troutman Sanders Employee Benefits & Executive Compensation attorneys are teaming with our future colleagues at Pepper Hamilton to help you stay on top of legal issues during this crisis. We will be issuing guidance regularly. Please visit the Pepper Hamilton LLP / Troutman Sanders LLP COVID-19 Resource Center for COVID-19 news and developments, recommendations from leading health organizations, and tools that businesses can use free of charge. Please reach out to members of the COVID-19 Task Force of Troutman Sanders and Pepper Hamilton, or an attorney with whom you work, for guidance about COVID-19 and retirement plan related issues.
The American Retirement Association is working with key lawmakers to pass legislation providing tax relief to individuals and employers that suffer a sustained economic loss from the COVID-19 emergency. While legislation is pending, employees may look to their retirement accounts to help cover the costs of unforeseen medical expenses and other financial hardships experienced during these uncertain times. Employers are simultaneously searching for ways in which they can provide assistance through their employer sponsored retirement plans, including suspension of elective deferrals, hardship withdrawals and loans. At the same time, in the wake of growing cash flow concerns, some employers are considering suspending or reducing certain employer contributions. Employers are also facing staffing changes which may adversely impact their plans.
We have joined forces to put together this FAQ to answer commonly asked plan administration questions, summarize an employer’s continued fiduciary duties, and highlight plan amendments that may help ease the burden of the COVID-19 emergency on employees and/or employers. If you have any questions, are considering changes to your retirement plans or need assistance with employee communications, please contact any member of the Pepper Hamilton or Troutman Sanders Employee Benefits and Executive Compensation Practice Groups or the COVID-19 Response Team. We are here to help you in any way that we can.
This FAQ is current as of March 24, 2020. We will make every effort to update it as pertinent information becomes available.
Q.1 An employee has requested a hardship distribution from his 401(k) plan account to pay for expenses related to COVID-19. Does the COVID-19 emergency satisfy the requirements of an immediate and heavy financial need for a hardship distribution?
A.1 While the IRS has not issued specific guidance about hardship distributions related to COVID-19, hardship distributions from a 401(k) plan, if permitted under the plan, can be made if necessary to meet an immediate and heavy financial need. Under the IRS “safe harbor” regulations, such distributions are allowed for certain expenses for medical care, if the recipient of the medical care is the participant or the participant’s spouse, dependent or, if permitted under the plan, a named beneficiary under the 401(k) plan. Further, as the uncertainty of the COVID-19 emergency persists, the safe harbor regulations also permit hardship distributions if payments are necessary to prevent the eviction of the participant from the participant’s principal residence or foreclosure on the mortgage on that residence, or in the hopefully unlikely need to cover funeral expenses for the participant, the participant’s spouse, children, dependents or beneficiary.
Provided a plan has been amended to include “FEMA-designated disaster” as a permissible safe harbor reason for hardship withdrawal, qualifying individuals may also request a hardship withdrawal to cover expenses and losses incurred in connection with a disaster declared by the Federal Emergency Management Agency (FEMA). Qualifying individuals are individuals whose principal residence or principal place of employment is located in a FEMA-designated disaster zone. See Q&A 7.
In addition, employees who participate in a 457(b) plan or nonqualified deferred compensation plan may qualify for an “unforeseen emergency” distribution, if permitted under the plan. See Q&A 6. For an event to constitute an unforeseeable emergency, the event must both (i) arise from extraordinary and unforeseeable circumstances beyond the control of the participant and (ii) cause the participant a severe financial hardship that cannot be alleviated by compensation or reimbursement received from insurance or otherwise, by liquidation of the participant’s other assets, or by ceasing future deferrals of compensation.
Specific extraordinary and unforeseeable circumstances or events that might trigger an unforeseeable emergency include the following: (i) the illness or accident of the participant or his/her spouse, beneficiary, or dependent as defined in section 152 of the Internal Revenue Code (disregarding section 152(b)(1), (b)(2), and (d)(1)(B)); (ii) loss of the participant’s property due to casualty (including the need to rebuild a home following damage not otherwise covered by insurance); (iii) the imminent foreclosure of or eviction from the participant’s primary residence; (iv) the need to pay medical expenses (including nonrefundable deductibles) or prescription drug medications; (v) the need to pay for funeral expenses of the participant’s spouse, beneficiary, or dependent; and (vi) other similar extraordinary and unforeseeable circumstances arising out of events beyond the control of the Participant. Unlike a hardship distribution from a 401(k) plan, an unforeseeable emergency under a 457 plan does not include: (i) costs to purchase a home; or (ii) payment of tuition, education fees or room and board for up to 12 months of post-secondary education for the participant or his/her spouse, children or dependents.
Q.2We have long-term employees, many of whom are over age 59½. Can our plan permit in-service withdrawals, other than for hardship, that are not subject to the 10% early termination penalty tax?
A.2 Plans may also permit in-service withdrawals other than for hardships. However, most distributions made prior to the participant’s attainment of age 59½ will be subject to a 10-percent penalty. IRS rules relating to the availability of in-service withdrawals differ based on the type of plan (e.g., 401(k), 403(b), 457(b), etc.) and the type of contribution (e.g., employee deferrals, rollovers, employer contributions, etc.). For example, a 401(k) plan may allow for in-service withdrawals of employee deferral contributions at age 59½. In-service withdrawals of profit-sharing contributions may be permitted after a stated event or a specified number of years of participation in the plan – typically five years. If your plan does not already provide for in-service distributions, this is an option that you may wish to consider adding to your plan by adopting a plan amendment. See Q&A 6.
Q.3 Our 401(k) plan permits participant loans. Are there restrictions on whether we can approve an employee’s loan request?
A.3 Generally, loans from 401(k) and other defined-contribution retirement plans do not limit the purpose for which a loan can be taken, although this will depend on the plan terms and the plan’s loan policy. However, restrictions may apply to the number of loans that may be outstanding at any one time and the contribution sources from which loans may be funded. In addition, the amount of any loan, the repayment period, and other loan terms must comply with IRS rules for participant loans from retirement plans. Further, loans are generally secured by the participant’s account balance and repaid through payroll deduction, such that, except under limited circumstances where loan repayments may be suspended, a failure to timely make any loan repayment will result in a taxable deemed distribution of the outstanding loan balance. The plan’s loan policy should be consulted if a change in employment status is imminent and the ability to repay the loan may be in question. See Q&A 6.
Q.4 Are we able to suspend loan repayments for an employee who is temporarily on an unpaid leave of absence or on reduced pay work schedules?
A.4 Yes, provided the plan’s terms or loan procedures provide for such suspension, or are amended to provide for such (see Q&A 6), payments may be suspended for up to one year if an employee/participant is on a leave of absence (for reasons other than military service), either without pay from the employer or at a rate of pay that is less than the amount of the installment payments required under the terms of the loan (after applicable employment tax withholdings). However, the participant must repay the loan (including interest that accrues during the leave of absence) by the latest permissible term of the loan (no extensions), and the amount of the installments due after the leave ends must not be less than the amount required under the terms of the original loan.
Q.5 If loan repayments are not suspended, and a participant fails to timely make loan repayments, does a taxable deemed distribution occur?
A.5 A participant’s failure to make any loan repayment when due in accordance with the terms of the loan is a violation that results in a taxable deemed distribution at the time of the violation. However, the plan administrator may allow a cure period, which cannot continue beyond the last day of the calendar quarter following the calendar quarter in which the required loan repayment was due. Loan repayments made before the end of the cure period will not be deemed to be in default. If a loan repayment is not made before the end of the cure period, the loan will be in default and a taxable deemed distribution will occur. The entire outstanding balance of the loan (including accrued interest) at the time of the repayment failure will become taxable.
Q.6 Our plandoes not currently permit hardship distributions, in-service withdrawals, or loans. Are we able to amend our plan(s) to help our employees through the COVID-19 emergency?
A.6 Employers are able to amend their plans mid-year to permit hardship withdrawals, in-service withdrawals, and/or loans, or to amend loan procedures to provide for the suspension of loan repayments during an unpaid leave of absence. Employers whose retirement plans already permit hardship withdrawals or in-service withdrawals may be able to amend their plans to expand the contribution sources from which such distributions are permitted or increase the number of loans permitted.
Q.7Will the Robert T. Stafford Disaster Relief and Emergency Assistance Act (the “Stafford Act”) impact retirement plan distributions?
A.7 To date, President Trump has declared New York State, Washington State and California major disaster areas.
Provisions of the Taxpayer Certainty and Disaster Relief Act of 2019, signed into law on December 20, 2019, permits penalty-free qualified disaster distributions of up to $100,000 to a retirement plan participant whose principal residence is located in a qualified disaster area and who sustains an economic loss by reason of the qualified disaster. Because, among other things, the declaration of any disaster areas in connection with the COVID-19 emergency will be made after February 18, 2020, qualified disaster distributions will not be available to participants in the COVID-19 disaster areas.
However, participants may still be able to receive a hardship withdrawal in connection with the COVID-19 emergency if their employer retirement plan permits hardship withdrawals on account of a FEMA-declared disaster and the participant’s principal residence or principal place of employment at the time of the disaster was located in the area designated by FEMA for individual assistance with respect to the particular disaster.
We will continue to update the list of the declared disaster areas.
Q.8 Our plan includes 401(k) deferrals. Do we have to continue withholding elective deferrals and remitting those contributions?
A.8 Provided employees are being paid during any period of business closure in connection with COVID-19, employers should continue to withhold employee elective deferrals under any applicable 401(k) plan and timely remit those contributions. If employees are not paid during any period of business closure in connection with COVID-19, employers would not have to withhold elective deferrals for that period, because there would be no compensation for employees to defer under the applicable 401(k) plan.
Q.9Our plan includes discretionary employer contributions. Can we suspend those contributions at any time?
A.9 Yes. Provided employer contributions are entirely discretionary, an employer may suspend those contributions at any time.
Q.10 Our plan includes fixed employer contributions. Can we modify eligibility for those contributions in light of COVID-19?
A.10 If an employer makes fixed employer contributions, such an employer will want to review the plan’s provisions regarding eligibility for those fixed contributions. If the plan imposes any eligibility requirements (e.g., the employee be employed on the last day of the year with exceptions for terminations during the year due to a disability or retirement), for those employees who have already satisfied the requirements to receive fixed contributions, that right cannot be taken away retroactively. An employer may, however, consider amending eligibility requirements for future fixed contributions (e.g., an employer could choose to amend a plan to reduce or eliminate future fixed employer contributions in an effort to ease cash flow concerns). Before an employer makes any change to the fixed contributions under its plan, consideration should be given to any impact on applicable IRS nondiscrimination testing requirements.
Q.11 Our plan includes safe harbor contributions. Can we suspend or reduce those contributions in light of COVID-19?
A.11 If an employer sponsors a safe harbor 401(k) plan, there are restrictions on suspending or reducing employer contributions. An employer may only suspend or reduce matching safe harbor contributions if: (i) the employer is operating at an economic loss, or (ii) the employer’s safe harbor notice provided before the start of the current plan year included a statement that the employer may reduce or suspend employer safe harbor matching contributions midyear. Provided an employer fits within one of those two categories, the employer may suspend or reduce employer safe harbor matching contributions midyear if the employer satisfies additional criteria. First, the employer must distribute a supplemental notice to eligible employees at least 30 days before the effective date of the suspension or reduction. Second, the employer must provide eligible employees with a reasonable opportunity to change their deferral election before the suspension or reduction occurs. Third, the 401(k) plan must be ADP/ACP tested for the full plan year in which the suspension or reduction occurs using the current year testing method. Employers whose 401(k) plans provide for safe harbor nonelective contributions have greater flexibility to reduce or eliminate safe harbor nonelective contributions due to recent regulatory changes that eliminate the safe harbor notice requirement.
Q.12 Our company is struggling financially in connection with the COVID-19 emergency. We are considering layoffs. Could layoffs potentially affect our retirement plan?
A.12 Yes. Employers will want to consider whether partial plan termination rules may affect their retirement plan when determining whether to move forward with layoffs. The general rule is that a partial plan termination may occur when plan participation decreases by 20 percent or more. However, the ultimate determination is based on a facts and circumstances analysis by the IRS. The partial plan termination rules would require an employer to fully (100%) vest all participants affected by a partial plan termination. Keep in mind that a partial plan termination could occur as a result of a single group layoff or multiple group layoffs.
Q.13 If we hire temporary employees to supplement our workforce during the COVID-19 emergency, when are they eligible to participate in our retirement plan?
A.13 It depends upon the eligibility terms of the applicable plan. The employer needs to consider the current service requirement for the plan. A plan with immediate entry or some other short waiting period will also have to cover temporary employees immediately or upon their meeting the plan’s waiting period. An employer cannot exclude employees based solely on a service class definition that assumes a length or hours of service (e.g., temporary employees). However, an employer may elect to apply a longer waiting period for temporary employees as a class, provided that if a temporary employee completes at least 1,000 hours of service in an “eligibility computation period,” the employee will enter the employer’s plan, for purposes of making any elective deferrals and receiving any employer contributions, on the next entry date following the end of the eligibility computation period in which he or she completes 1,000 hours of service, provided the employee is still employed by the employer on that entry date. Employers who hire temporary employees in response to the COVID-19 emergency and wish to apply an eligibility waiting period for plan participation that is greater than the eligibility requirement applicable to the rest of its workforce should consider the impact on the plan’s IRS required nondiscrimination testing and changes in administrative processes.
Q.14 Our retirement plan’s investment performance is declining in connection with the COVID-19 emergency. Should our plan fiduciaries revisit investments?
A.14 Plan fiduciaries have an ongoing responsibility to monitor the investment options offered under their retirement plans. In a normal environment, plan fiduciaries should review the plan’s investment funds on a quarterly basis. In light of the COVID-19 emergency and the impact on the financial markets, it is prudent for plan fiduciaries to review the plan fund menu more frequently. In addition, plan fiduciaries should check the plan’s investment policy to determine what, if any, actions are required in this case. Plan fiduciaries should continue to monitor investment performance, consult with their plan’s investment advisors and plan financial advisors, and document steps taken to monitor the plan’s investment performance.