Compliance May 22, 2020

Implementation of Coronavirus-Related Distributions in DB Plans

DB plan sponsors may want to offer coronavirus-related distributions under the CARES Act, but should understand certain rules before doing so.

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Provisions in the Coronavirus Aid, Relief and Economic Security (CARES) Act don’t only apply to defined contribution (DC) plans; some apply to defined benefit (DB) plans as well. For example, DB plan sponsors may offer coronavirus-related distributions (CRDs) to participants, subject to certain plan and regulatory rules.

The provisions for CRDs contained in the relief bill apply to DB plans in the same way they do to DC plans, as long as pension plan sponsors had previously allowed for in-service distributions, says Brian Donohue, a partner at October Three in Chicago.

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Participants in both types of plan qualify for a distribution if an individual was diagnosed with COVID-19, had a spouse or dependent who was, or experienced adverse financial consequences as a result of the COVID-19 crisis. Plan sponsors may rely on participant self-certification that the participant has been affected. “If employers are worried about employees claiming hardship, it’s not their responsibility to monitor that,” Donohue states.

Hitz Burton, partner for legal consulting and compliance at Aon, says DB plan sponsors can only provide coronavirus-related distributions to those otherwise eligible for a distribution under the Internal Revenue Code, such as a terminated, vested or retirement-eligible former employee, as long as the distribution is permitted by plan terms. Additionally, coronavirus-related distributions can be used in a DB plan that permits distributions at attainment at age 59 1/2 or older as a de-risking opportunity, he adds.

The CARES Act does not change when a distribution may be made to a DB participant, October Three explains in a post on its website. However, for other participants, including those “furloughed”—but not permanently “separated from employment”—active employees older than age 59 1/2 and retirees, the answer is more complicated. The firm recommends DB plan sponsors review these issues with counsel if they are interested in making 2020 lump-sum distributions to one or more of these groups. “We are going to need some guidance from the DOL [Department of Labor] in terms of model language, because that will need to be modified this year when it comes to these distributions,” Donohue says.

Since the CARES Act removed certain requirements, these new distributions are an attractive option for some, he adds. For example, while traditional in-service distributions are subject to a 10% early withdrawal tax, a CRD is not. Additionally, CRDs can be included in taxable income over a three-year period and may be recontributed to the plan during this period.

DB plan sponsors that consider adding a CRD option to their plans should be mindful about certain provisions. For example, the $100,000 limit on these distributions must be monitored and applied across qualified plans—both DB and DC—that are sponsored by the employer, Burton notes. “Because of the likely difficulty and associated compliance risk with monitoring the $100,000 limit across multiple plans, Aon generally recommends that a sponsor considering a CRD provision only do so for a single qualified plan within its controlled group,” he adds.

DB plan sponsors offering lump sums today, but not administering a CRD provision for 2020, also have an important disclosure point to consider, Burton warns. The information provided to participants in the current IRS safe harbor special tax notice has not been updated to describe important information regarding the tax-favored treatment available to qualified individuals affected by COVID-19. Under the CARES Act, for example, qualified individuals who receive an eligible rollover payment (e.g., lump sum) in 2020 can recognize the taxable income over a three-year period. “As a result, we believe that plan sponsors should consider providing all participants with additional information about how the CARES Act may impact the federal income taxes that they will owe,” he says.

Burton says Aon believes that CRDs in DB plans will be most prevalent in those plans that already offer lump-sum distributions—whether permanent or temporary—including cash balance and other hybrid pension plans. CRDs may also be offered as part of an early retirement or lump-sum window program in 2020.

Donohue notes that DB plan sponsors have long been crafting efforts to push participants to take lump sums instead of pension payments. Paying out lump sums reduces risk for the plan, and it reduces the overhead cost associated with Pension Benefit Guaranty Corporation (PBGC) premiums. Participants who may not have chosen a lump-sum distribution when the opportunity was offered to them before may do so now to reap the tax advantages of CRDs, he says.

But, in 2020, there’s a whole new set of reasons to move money out of pension plans, Donohue says. “Just how we’re seeing business loans and unemployment checks, everyone is just in this push to move money into the economy to continue the flow of things,” Donohue explains. “DB sponsors are looking at this opportunity to be a part of that, to try to provide lifelines to participants.”

Benefits May 22, 2020

Emergency Savings Post-COVID Will Be Viewed Differently

The retirement plan system has the infrastructure to get people started building emergency savings.

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The Defined Contribution Institutional Investment Association (DCIIA), the SPARK [Society of Professional Asset Managers and Recordkeepers] Institute, the Plan Sponsor University and the Retirement Advisor University on Friday held a timely webinar on the future of emergency savings.

Speakers included Tim Flacke, executive director of Commonwealth; David John, senior strategic policy adviser for AARP; and Christine Lange, head of retirement business management and customer solutions at Prudential Financial.

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The trio described the economic devastation that has been wrought in the United States by the coronavirus pandemic, describing in stark terms the massive jump in unemployment that has already occurred. Yet they also voiced hope that this dire situation will lead to a fundamental rethinking of the way working Americans spend and save.

“The financial well-being of many Americans is not as strong as it appears to be or as it should be, and that fact has been made very clear in the last two months,” Flacke said. “We have literally seen miles-long lines of people waiting to get food. What is really eye-opening is that, when you look closely at the news coverage, you will see a lot of quite nice and new-looking cars in those lines. What that demonstrates is that the majority of Americans, whatever their income level, had been living very much in the present in terms of their finances.”

The panel noted that a similar phenomenon was observed during the federal government shutdown back in January 2019, but, at the time, the widespread nature of the situation was not fully appreciated.

“Many of those people who were furloughed by the federal government were well paid, but even for them, one or two missed paychecks became an economic disaster,” Flacke observed. “We have all seen the research showing as many as three in four Americans are living paycheck to paycheck. One Willis Towers Watson survey puts the figure at 40%, but that’s just for people working with the largest and most successful U.S. employers.”

Changing this situation will take years of concerted effort, the panel members agreed, but the job should be made at least a bit easier now that the coronavirus pandemic has cast so much light on the United States’ financial weak points. The group proposed that the retirement plan services industry can be the fulcrum for change, because getting people to commit to emergency savings will take many of the same strategies and solutions as it takes to get them to start saving seriously for retirement.

“One clear lesson we can bring to the table from the retirement planning perspective is that people should be encouraged to start small and to automate their savings—and we can’t make them feel daunted by saying they need to have six months’ expenses saved in cash in their bank,” Flacke said.

John noted that AARP has conducted research into three different emergency savings models—all of which can be very effective but which will also require regulatory changes and a commitment from employers and financial services providers. The first two are variations of creating after-tax savings sub accounts within existing retirement plans. The third is to use separate, parallel savings accounts at a bank or credit union while relying on payroll deferrals to automatically fund the account.

“All three models are focused on the ability to use automatic enrollment and regular, if small, contributions,” John said. “Again, one thing we don’t want to do is to structure the savings goals in a way that discourages people from participating. We want people to feel good about saving relatively small amounts in each paycheck. Unfortunately, we have found that there are regulatory complications for all three of these models at the moment. The current automatic enrollment safe harbors meant for retirement plans aren’t sufficient, and so we need to update these regulations to make emergency savings easier, simpler and cheaper. For regulators, it should not take a lot of work to do these updates, we believe.”

Lange echoed that point and said the retirement plan services industry is eager to provide emergency savings solutions, adding that plan sponsor clients are always hesitant to adopt solutions or strategies that have not been explicitly approved by regulators.

“For many workers, and not just those lower on the income scale, life is a regular string of financial stresses and emergencies,” she said. “Understanding that will help us create a better solution. Before we can prepare people for another pandemic, we need to start by helping people prepare for the episodic challenges that emerge in normal life—the flat tire, the hole in the roof, a week without pay. To do this, we can and should use the retirement plan industry’s infrastructure. It’s a very powerful system, and we need to take advantage of it.”

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