A Round Up of Recent, Significant Employee Benefit Plan Developments
With the virtually limitless ways the COVID-19 pandemic has changed the workplace and home life in recent months, coupled with a deluge of guidance from the IRS, the Department of Labor and the U.S. Supreme Court, it would be understandable for even the most diligent Employee Benefits and Human Resources teams to have missed some relevant information.
With that in mind, we have assembled some of the key employee benefits information of the last two months here. In addition, please access our earlier Employee Benefits Client Alerts on the SECURE Act, the CARES Act, and extensions of certain deadlines for benefit claims and COBRA elections or by visiting the Quarles & Brady LLP COVID-19 Resource Center. Since those earlier Alerts, we have received guidance on important topics including:
- Clarification on the CARES Act, including Distributions and Loans, as well as Loan Suspensions
- Cafeteria / Flex Plan Provisions, including Changing Elections Mid-Year and Carryovers
- Spousal Consents to Distributions Without Physical Presence
- Electronic Disclosure of Certain Retirement Plan Information
- Use of Private Equity in Defined Contribution Plans
- Fiduciary Investment of Defined Benefit Plan Assets
- Waiver of Required Minimum Distribution Requirements for 2020
Clarification on the CARES Act
Guidance on Distributions & Loans
Although the CARES Act offered many new distribution and loan options to those affected by COVID-19, it unfortunately left plan sponsors with many questions as well. In Notice 2020-50, the IRS resolves many of those items.
Coronavirus-Related Distributions ("CRDs")
The CARES Act permits certain plans to authorize CRDs of up to $100,000 to "Covered Individuals" ("CIs").
In defining CIs, the law includes participants who are diagnosed with COVID-19 as CIs as well as participants whose spouses and dependents are diagnosed. Secondly, CIs include participants who experience "adverse financial consequences as a result of": the individual being quarantined, furloughed or laid off or having work hours reduced; the individual being unable to work due to lack of childcare; or the closing or reducing of hours of a business owned or operated by the individual.
The Notice adds several more types of CIs:
- Individuals whose pay is reduced or has a job offer rescinded or start date delayed;
- The individual's spouse or household member experience such factors or the "adverse financial consequences" described above; and
- Closing or reducing of hours of a business owned or operated by the participant's spouse or member of the participant's household.
The IRS clarified that an individual (not the employer) is ultimately responsible for determining and representing to the IRS whether a distribution is a CRD.;
Also, if a participant takes distributions from multiple plans (of different employers) that total over $100,000, the individual employer's plan is not at risk as long all plans of the employer, in aggregate, have not made distributions in excess of that amount.
Notably, if a distribution could qualify as a CRD, an individual (including a participant or beneficiary) can make that determination after the payment is made and report it accordingly on their tax return for the year (or spread tax over three years (as is permitted for CRDs)). Note that this treatment goes so far as to allow loan offsets to be taken into account over three years (but not deemed distributions of plan loans).
Further, the guidance clarifies that the amount withdrawn need not correlate to a particular expense, the CI's need for funds, or the extent of the adverse financial consequences experienced by the CI. Rather, the only requirements is that the distribution relates to a CI.
In general, a CI may recontribute amounts taken as CRDs within three years of such distributions. The guidance clarifies, however, that while an unlikely scenario, a CRD made to a beneficiary may not be recontributed as a rollover within three years.
Consistent with the other comments above, it also clarifies that even if, for example, an amount was taken as a hardship distribution, but based on current guidance would have also satisfied requirements to be a CRD, it may be treated as a CRD for tax purposes (and thus taxed over three years, not be subject to early distribution penalties and eligible for recontribution within three years).
Plan Provisions Which May Be Disregarded
As somewhat of a surprise, the IRS indicated that the CARES Act does not supersede plan requirements like spousal consent and annuity forms of distribution. The law itself indicates that a CRD will not be treated as violating any part of Code Section 401(a) and then goes on to specify certain parts of the Code that are specifically not violated (like rules prohibiting distributions of 401(k) amounts except in limited circumstances).
Oddly, the statutory language suggests that spousal consent and mandatory annuities would be included in the provisions that are disregarded for CRDs, but consistent with its guidance many years ago regarding hurricane-related distributions, the IRS reads the distribution authorization narrowly.
Withholding on CRDs
Withholding on CRDs is voluntary even though amounts can be rolled over. The employer is not required to provide the 402(f) rollover notice and the 20% mandatory withholding for eligible rollover distributions does not apply.
Certifications by Employees
Unless it has "actual knowledge" to the contrary, an employer may rely on a certification by an employee that they are eligible for a CRD. In fact, the guidance provides a sample acceptable certification. Importantly, actual knowledge means knowledge without any investigation.
Plans can report CRDs on Form 1099-R as Code 2 (early distribution, exception applies) or Code 1 (early distribution, no known exception). Since the participant is ultimately responsible for representing whether a distribution is a CRD when they file their tax return, the coding is not overly importantly. However, plan sponsors should be aware that, even if a portion of the distribution is repaid to the plan within the same year, the distribution must be reported for that year.
Participants will use new Form 8915-E to report the amount of CRD tax due for the year and any amount recontributed. However, once the tax filing deadline (including extensions if elected) has passed, an election made as to whether to take all amounts into income in the year of distribution or over three years is irrevocable.
A plan sponsor must reasonably conclude that an amount is a recontributed CRD when it accepts such an amount as a rollover. As with the certification above, here a plan sponsor may accept an individual's representation unless it has actual knowledge to the contrary.
Plans are not explicitly required to accept recontributions, but the IRS anticipants that plans will generally accept recontributions if they accept other rollover contributions.
The tax reporting of recontributions is rather complex. Essentially, if an individual recontributes an amount in one of the three years over which it will be taxed, it first reduces the taxable portion of the distribution for that year. Any excess can be carried forward or back to one of the other two years. And, it may be necessary to file amended returns if an amount is carried back to a year for which a return has already been filed. Much of this information will be reported through Form 8915-E.
Suspension and Extension of Loans
Under the CARES Act, a plan may permit a loan repayment due between March 27 and December 31, 2020 to be delayed for up to one year for a CI, provided adjustments are made for amortization and accruing interest. While the IRS allows employers some latitude in determining how to apply the statutory language, it offers a safe harbor.
Under that safe harbor, loan payments may be suspended for up to the maximum suspension period (March 27 and December 31) and the loan term extended for one year (even if that extends the loan past the normal five year limit). The loan repayments must resume after the end of the suspension period (generally in January 2021). Interest accruing during the suspension period must be added to the loan principal, and then the new payment amount must be made over the new extended period.
As with CRDs, the plan sponsor may rely on participant representations unless it has actual knowledge to the contrary.
A CRD is a sufficient basis for cancelling a deferral election under a nonqualified deferred compensation plan and is treated as a 401(k) hardship distribution for this purpose. The deferral election must be canceled, not merely postponed or otherwise delayed.
In May, the IRS provided useful new options to employers and employees who use "Cafeteria Plans" or "Flex Plans" as part of their benefit programs.
Most notably, the IRS is allowing employees to make adjustments to their health flexible spending accounts ("Health FSAs") and dependent care accounts ("DCAPs") at any time during 2020, regardless of whether such individuals have experienced an event that would allow a change under ordinary election change rules. Other recently issued guidance increased the amount available for carryover for plans that offer that option.
Changing Elections Mid-Year
Under Notice 2020-29, plans may permit employees to change elections on pre-tax health insurance premiums as well as increase or decrease their Health FSA and DCAP amounts during the 2020 calendar year. Among other things, an employer could allow employees to make an initial election for any or all of these benefits for the 2020 year (even if they previously declined to participate). Notably, plan sponsors can prevent an employee from electing a smaller amount than the amount the employee has already spent (since, for example, employees are entitled to their entire Health FSA election at any time during the year but typically contribute out of payroll ratably over the year).
Importantly, an employee need not demonstrate that a change is related in any manner to the pandemic. Furthermore, these are optional changes, so plan sponsors should evaluate whether they will provide meaningful benefit to their employees. If they decide to implement these changes, however, their plans must be amended by the end of 2021 (although the amendment can be fully retroactive to the date a sponsor first permitted the election changes).
Many cafeteria / flex plans allow plan participants to expend amounts they have contributed not only for the plan year, but also during a 2-1/2 month "grace period" after the plan year ends.
Recognizing that health care and daycare spending patterns have likely changed in unpredictable ways in 2020, in Notice 2020-33, the IRS permits plan sponsors to grant an extension in which a participant may use amounts carried over from a prior plan year. Specifically, a plan sponsor may choose to amend its plan to allow a participant to use amounts -- that were subject to a grace period or relate to a plan year ending in 2020 -- for an expense incurred prior to the end of 2020.
Certain cafeteria / flex plans allow a participant to carry up to $500 forward from one plan year to the next. So, similar to the above, the IRS also will permit such a $500 carryforward to be used at any time prior to the end of 2020.
(As a footnote to the above, and technically unrelated to that, the IRS has also increased the maximum carryover from $500 to $550 for amounts that would be carried into 2021 and beyond. Employers who wish to allow this additional amount may need to modify their plans to provide for it.)
Spousal Consents to Distributions Without Physical Presence
Certain actions (like loans and most distributions) from certain qualified retirement plans require spousal consent for married participants. While the IRS and DOL have long permitted participant consents through electronic means, they have remained concerned about obtaining spousal consents through such methods. Thus, absent guidance, spousal consent would continue to require in-person witness by plan representative or notary public in order to verify spousal consent to such action.
In light of the pandemic, in Notice 2020-42, the IRS grants relief for calendar year 2020 from the physical presence requirement for such consents. The relief takes two forms:
- If the witness is a notary public, such witness may use a live electronic audio-visual system so long as the witness is otherwise consistent with retirement plan requirements and is consistent with state law governing the notary public. Generally, we think that a video chat, with proof of identification shown clearly to the notary via a computer camera, should suffice.
- If the witness is a plan representative, live audio-visual technology is permitted so long as:
- The individual signing presents a valid photo ID during the video conference;
- The video must permit live interaction between the witness and the individual signing;
- The individual must provide a legible copy by fax or electronic means on the same date as it is signed; and
- The plan representative must acknowledge in writing that they witnessed the signature and transmit such acknowledgement back to the individual signing.
Electronic Disclosure of Certain Retirement Plan Information
With the rapid pace of technological change, DOL rules regarding disclosure had fallen out of sync with most users' ability to access and understand materials provided through electronic means. With that in mind, the DOL proposed and now has finalized updated guidance for certain retirement plan disclosures.
Namely, under a new safe harbor, website posting and email delivery will satisfy plan sponsors' obligations to deliver many common plan materials to participants. Documents covered by this rule include summary plan descriptions, summary annual reports and benefit statements, among others. At this time, the safe harbor does not apply to IRS disclosures (like 401(k) automatic enrollment and safe harbor notices) or to health plan disclosures.
There are a few important details, however:
- The plan sponsor must use a valid email address for the participant. Unless the address is provided by the participant to the plan sponsor, the burden for ensuring that the address is valid effectively remains with the sponsor.
- Plan participants must be permitted to request a paper copy, free of charge.
- Plan participants must receive initial notice of the change to electronic delivery in a paper format.
- Participants must generally be notified each time a new document is made available (along with a brief description of such document and certain other information). A combined annual notice is allowed for summary plan descriptions and certain annual notices (including participant-level fee disclosures and qualified default investment alternative notices).
- Documents may be posted and accessed on the plan sponsor's intranet or on a service provider's (such as a recordkeeper's) website.
- Importantly, covered documents (even if superseded) must remain on the website for at least one year.
Use of Private Equity in Defined Contribution Plans
In letter format, the Department of Labor provided assurance that private equity investments could be included in defined contribution plans under certain limited circumstances. In particular, the letter addressed the use of private equity investments within professionally managed funds that are offered as part of a multi-asset class vehicle structured as a custom target date, target risk, or balanced fund.
Private equity funds, as a rule, are typically not easy to purchase and sell and often have limits on timing when individuals may receive cash distributions. Additionally, these investments often are not valued as frequently as other investments and can entail a significant amount of risk and may not be appropriate for all investors.
Nevertheless, under this informal guidance, the DOL confirmed that normal fiduciary responsibilities apply to plan administrators who may include such investments in one or more of their defined contribution plan investment options. For example, the inclusion of such a vehicle should be consistent with prudence and diversification of the overall portfolio of options. Additionally, the DOL cautioned that the individuals deciding on inclusion of such an investment must be sufficiently knowledgeable about such investments if they choose to include them. Moreover, the fiduciary should determine whether inclusion of such an investment is appropriate in light of their participant base.
Thus, while this guidance may offer a new investment avenue for plans, inclusion of private equity in one or more investment options will require careful analysis.
Fiduciary Investment of Defined Benefit Plan Assets
In Thole v. U.S. Bank N.A., the U.S. Supreme Court ruled that participants did not have a basis to challenge the investments made by their defined benefit plan because the plan was adequately funded. Interestingly, U.S. Bank made additional contributions to improve the funding status of the plan after the complaint was filed, which worked to negate the participants' claims.
Defined benefit plans promise participants a monthly benefit at retirement often based on their length of service and compensation. In order to provide such benefits, sponsors of such plans contribute money over time which is invested with the target of having sufficient funds to pay each participant's benefits as they become due. Thus, in funding a defined benefit plan, both participant lifespans and expected rates of return come into play.
In a recent ruling, the Supreme Court confirmed that, so long as they receive the payments to which they are entitled, participants do not have the right to challenge the investments of their plan. Thus, the participants claim that the fiduciaries owed the plan $750 million was dismissed.
Waiver of Required Minimum Distribution Requirements for 2020
With securities markets plunging in the wake of the pandemic, followed by daily jumps and drops of several percent, the IRS thankfully has recognized that participants could experience serious negative financial consequences if they were forced to take required minimum distributions ("RMDs") in these turbulent times.
Each year, defined contribution plan participants who have both terminated employment and reached age 70-1/2 (changing to age 72 going forward under the SECURE Act) must withdraw a portion of their account based on their life expectancy and the value of that account at the end of the prior calendar year. While markets soared in late 2019, they dropped precipitously more recently. The net effect of that combination was that, for participants who needed to take distributions in 2020 (in some cases, by April 1, 2020), RMDs based on 2019 end-of-year values would result in distributions representing much-larger-than-typical portions of their plan accounts.
In Notice 2020-51, the IRS interprets and expands on RMD relief included in the CARES Act, which provided for a waiver of RMD requirements for defined contribution plans and IRAs for 2020.
Following on that legislation, the IRS will allow individuals who received a distribution (that would have constituted an RMD) to rollover such amount to a qualified plan or IRA by August 31, 2020 (or, if later, 60 days after it was distributed). The guidance permits rollovers of amounts that are part of a stream of payments over the life expectancy of the participant (and spouse, if applicable) or periods of at least 10 years. It also applies to amounts that will be paid in 2021 before April 1, 2021 (for those who are newly RMD-eligible).
The IRS addresses a few other related impacts of these changes. For example, it clarifies that if a beneficiary (of a participant who died in 2019) would have had to elect by the end of 2020 as to whether to take distributions in a life expectancy form or over five years, the beneficiary will now have until the end of 2021 to make the decision.
Finally, the Notice includes sample plan amendments that can be adapted to both pre-approved and individually designed plans. Plan sponsors may choose whether to automatically suspend RMDs for 2020 or to suspend RMDs only if requested by a participant or beneficiary. Plan amendments must generally be adopted by the end of the 2022 plan year.
Congratulations if you made it through this odyssey of regulatory and judicial guidance. We appreciate that this guidance is a lot to take in, process and apply, so we are here and ready to assist in evaluating your plan provisions and compliance requirements as needed.
For more information on these provisions or for questions, please contact your Quarles & Brady attorney or: