A New Law, A New Challenge

​The recently passed CARES Act is designed to provide stimulus and economic support during the COVID-19 pandemic. The largest such relief of its kind in history, it’s not surprising that there is much to the legislation.  The law itself runs for 880 pages.  And like all big pieces of legislation, there are provisions affecting your retirement plan.  Let’s take a look at one.
 
One of the provisions getting the most press permits eligible employees to take hardship distributions from their qualified accounts penalty free up to $100,000.  Normally, a Hardship Distribution that occurs before 59 ½ is subject to both income taxes as well as a 10% early withdrawal penalty.  Waiving the withdrawal penalty seems like a humanitarian gesture in this time of need.  But as with most things like this, the initial gesture can get complicated quickly.
 
For one thing, the law permits the income tax on the distribution to be paid over a period of 3 years, but it does not require this.  Presumably an employee would make some kind of election as to how to pay this tax – all at once, evenly spread, some here/some there, etc.  But because the amount is treated as ordinary income, it would get lumped in with all other earned income and considered part of your Modified Adjusted Gross Income (“MAGI”).  This by itself is going to require some real planning.  But wait, it gets better.
 
On the top of page 159 of the CARES Act there is a specific provision that allows, but does not require, someone who has taken a distribution to repay the amount of the distribution into the same qualified account from which it came or another qualified account if the repayment occurs within 3 years.  If the amounts taken, or some of the amounts taken are repaid, those amounts are not considered taxable income.  It would sort of be like the distribution never actually occurred, and no tax would be owed on those amounts repaid.  
 
What if an employee chose to pay all the tax this year, and in 2 ½ years when this whole crisis is in the rear-view mirror decides to repay some of the original distribution?  It would seem as though the employee should receive credit for the taxes paid originally, right?  Double taxing the same dollars would be inappropriate. I’m sure we will get guidance on this, but the law is silent.
 
And on top of all this, if the distribution is from an employer qualified retirement plan versus an IRA, this whole thing has to be approved by an employer.  The employer is not required to permit hardship distributions.  And what type of reporting might the employer need to consider if these distributions, repayments, and taxes all need to be tracked and monitored?  What if the distribution comes from your plan but the employee repays the amount to an IRA?  Or another plan?
 
If you are an employer looking for good counsel during these times, I would encourage you to give me a call. This is not the time to try to figure this stuff out on your own. 
 
Pete Welsh a/k/a 401kGuy