COVID-19 Compliance Corner: New Loan Provisions Under the CARES Act

The Coronavirus Aid, Relief and Economic Security (CARES) Act provides temporary relief from some plan loan requirements for loans made and repayments due beginning March 27. These provisions apply to qualified plans such as 401(k) and profit sharing plans, 403(b) plans and governmental 457(b) plans but, unlike the distribution provisions, do not apply to individual retirement accounts (IRAs). IRA owners are not allowed to take loans from their IRAs.

What Are the Basic Plan Loan Rules?

Plan loans are not treated as taxable plan distributions so long as they are within the Internal Revenue Code limits and are repaid with interest on a level basis over the loan term. While loans may be made from defined benefit (DB) pension plans as well as defined contribution (DC) plans, defined benefit plans do not usually provide for loans. Most 401(k) plans and many other defined contribution plans do.

Loans are permitted under the “regular” rules if the total amount borrowed, including loans outstanding over the past 12 months, does not exceed the lesser of: $50,000 or  half of the participant’s vested account balance. The term may not exceed five years unless the loan is used to purchase a principal residence. When a participant fails to make a loan repayment on time, the loan is in default after any grace period has expired, and the entire outstanding principal plus accrued interest is subject to immediate taxation.

How Does the CARES Act Change These Rules?

The CARES Act permits, but does not require, plan sponsors to increase the amount that may be borrowed by “qualified individuals” and/or to delay certain loan repayments by “qualified individuals.” The provisions are effective during different time periods.

Who Is a Qualified Individual?

Like CARES Act distributions, the special loan rules apply to individuals if they or their spouse or tax dependent has been diagnosed with the coronavirus using a test approved by the Centers for Disease Control and Prevention (CDC) or if they have experienced COVID-19-related adverse financial consequences as a result of being quarantined, furloughed or laid off or having work hours reduced, or as a result of being unable to work due to lack of child care, or the closing or cutback in hours of a business owned or run by them. CARES Act loan provisions do not apply if the participant’s spouse or dependent rather than the participant suffers those adverse financial consequences. In that event, the spouse would have to qualify under the spouse’s plan. Other criteria may be added by the Secretary of the Treasury, but none have been added so far.

Special Relief

If permitted by their plans, “qualified individuals” may borrow up to a total of $100,000 or the value of the participant’s vested account balance, if less, during the period from March 27 to September 22. A participant with a $30,000 loan outstanding and a $150,000 vested account balance could be permitted to borrow an additional $70,000 under this CARES Act provision. A loan limit between $50,000 and $100,000 would also be permissible.

The CARES Act also permits an optional “one year delay” for each loan repayment due between March 27 and December 31. If a plan adopts this provision, a participant who could not make loan repayments during this period would not go into default or be subject to taxation. I put “one year delay” in quotes because, based on prior guidance issued by the IRS interpreting similar legislation, which the IRS recently advised us to consult, it appears that the maximum suspension period will actually be limited to nine months and that repayments may be required to commence again as of January 1, 2021. We await further guidance on that point. The period during which repayments were suspended is later added to the term of the loan and future payments must be adjusted to take into account interest accruing during the repayment suspension.  

Plan Sponsor Decisions Are Voluntary and Independent

IRS guidance indicates that plan sponsors can adopt either or both (or neither) of the CARES Act loan provisions regardless of whether they elect to provide the special CARES Act distributions discussed in last week’s column. However, plan sponsors should be careful to check the exact language in their plan documents because there may be an exception if the plan documents simply incorporate by reference the loan requirements in the Internal Revenue Code. Since the CARES Act amended those provisions, the new limits may have come into effect automatically under the plan’s language and plan sponsor action might be required to change them.

Implementation

Plan sponsors considering the new loan provisions should ascertain that their vendors and recordkeeper can administer them. This is particularly important if a loan limit between $50,000 and $100,000 is under consideration. Plan sponsors adopting the new loan rules should also communicate the availability of the loan relief to their participants. Due to the complexity of these rules, they may wish to have their ERISA [Employee Retirement Income Security Act] counsel review any communications.

Carol Buckmann is a co-founding partner of Cohen & Buckmann P.C. As a highly regarded employee benefits and ERISA [Employee Retirement Income Security Act] attorney, Buckmann deals with the foremost issues in ERISA, including pension plan compliance, fiduciary responsibilities and investment fund formation.

She has 40 years of practice in this area of the law and a depth of experience on complex pension law and fiduciary problems. She regularly shares her thoughts on new developments in the benefits industry on Insights, Cohen & Buckmann’s blog, and writes and speaks on ERISA topics. Buckmann has been recognized by Martindale-Hubbell as an AV Pre-eminent Rated Lawyer, was selected for inclusion in the Best Lawyers in America and was named one of the Super Lawyers in Employee Benefits.