Among the many retirement plan focused provisions included in the Coronavirus Aid, Relief and Economic Security (CARES) Act is an easing of the rules and penalties restricting early withdrawals from defined contribution (DC) retirement plans.
The law created a new emergency retirement plan distribution option dubbed the “coronavirus related distribution,” or “CRD” for short. Under the CARES Act, a CRD can be drawn from an employer sponsored retirement plan, such as a 401(k) or from individual retirement accounts (IRAs), in any amount up to $100,000. The normal 10% penalty tax levied on early plan distributions by the Internal Revenue Service (IRS) is waived for CRDs, and furthermore, the individual taking a CRD can spread the reported income over three years for tax purposes. The distribution also can be repaid within three years to avoid taxation.
Financial advisers know hardship withdrawals are one of the main sources of leakage from DC plans, and in normal circumstances, they do all they can do limit such leakage. But the coronavirus pandemic is a different situation, says Ross Bremen, a partner in NEPC’s defined contribution practice.
“The global impact of the disease itself is unprecedented in our lifetime,” Bremen observes. “This is a novel situation—people can’t go out to work and they can’t live their normal lives. Many people have died, and unemployment levels have spiked in a way that we have never seen before. The markets have obviously been severely impacted.”
In a word, the global health care and financial systems and all of their constituents, from major corporations to individual Americans, are facing serious hardships, Bremen says. For that reason, it makes sense that Congress has taken the dramatic step of giving plan sponsors significant room to expand their pre-retirement hardship withdrawal programs.
“The hardship expansion will clearly help some Americans who are facing a cash crunch,” Bremen says. “However, we as an industry need to be careful about explaining some of the mixed messages in this relief package.”
RMDs Versus CRDs
The main mixed message of the CARES Act, Bremen and others say, is that, on the one hand, it waives all required minimum distributions (RMDs) for 2020, based on the understanding that forcing retirees to pull money out of their equity investments right now will lock in the significant losses experienced so far this year. But at the same time, the law is seeking to make it easier for people who are not yet retired to make early, penalty-free hardship withdrawals of up to $100,000. Making such withdrawals right now—assuming the dollars are coming from the sale of equity investments—will lock in dramatic equity losses, just like taking an ill-timed RMD.
“As advisers and service providers, it’s our job to help cut through these mixed messages and help sponsors and participants make the best decisions,” Bremen says. “Participants, especially, must understand the impact of taking money from retirement plans in declining markets. Even backing away for a short time can be very detrimental. We saw in the last two weeks that missing a single day can mean missing an 11% bounce.”
Mark Iwry, former senior adviser to the secretary of the treasury in the Obama administration and currently a nonresident senior fellow at the Brookings Institution and a visiting scholar at the Wharton School, agrees with that assessment.
“The CARES Act retirement distribution [CRD] and loan provisions may represent a bit of a reflexive reaction,” Iwry says. “Of course many Americans are now facing extraordinary financial exigencies, and some will have to turn to their retirement savings as a last resort for liquidity. But, I think we need to be careful with at least our messaging about CRDs and loans to make sure participants understand the potential impact on retirement security.”
Iwry says it might even be appropriate for plan sponsors to consider first implementing the more generous CARES Act loan provisions doubling the amount of loans that participants can take—from $50,000 to $100,000—and extending loan repayment periods. Sponsors might then assess employees’ need and demand for CRD distributions in addition to loans.
“I also wonder whether the $100,000 CRD provision will have an ‘endorsement effect,’” Iwry says. “Will some participants see this as an invitation from the government and their employer to consider withdrawing up to $100,000 penalty-free, and perhaps borrowing up to another $100,000 during the statutory window even if they don’t urgently need them?”
In other words, some financially secure workers who might not need up to $100,000 (or $200,000 including the loan) in cash right now might see the CRD as a window to access funds penalty-free for a future emergency, or for another financial purpose beyond paying near-term bills and expenses.
“Participants could be tempted by the optionality of being able to repay the CRD distribution within the three year window to avoid income tax, but meanwhile holding onto it as a security measure in this uncertain time,” Iwry observes. “Unfortunately, taking the distribution during the current market dip will probably amount to a sell-low, buy-high strategy—buying into equities after the market has recovered if they repay the CRD. Also, that distribution will readily spend itself in the near term, but later will be hard to reconstitute and recontribute. By contrast, behaviorally, a plan loan benefits from the greater discipline of steady loan repayment via required automatic payroll deduction, unless employment terminates during the repayment.”
Steps by Providers
Charlie Nelson, chief executive officer, retirement and employee benefits, Voya Financial, says retirement plan recordkeepers are also concerned about leakage in this challenging time—though they are doing their part to provide liquidity to those who need it.
“With lost wages, significant health care costs and other unexpected expenses, we recognize that some may have no choice but to access their retirement savings to address the financial challenges that they are facing today,” Nelson says. “As always, we encourage individuals to balance their short-term cash needs with long-term goals, such as retirement readiness. We generally encourage individuals to consider flexible and health savings accounts [HSAs] for addressing health care costs. But, if a distribution from a qualified plan is needed, individuals should give careful thought to their options and consider several factors, including their short-term financial needs, tax implications and how they may replenish retirement funds in the future.”
Matching the steps taken by various other providers, Voya is providing Americans with free access to a range of online resources, such as CARES Act analysis and virtual group education meetings. The firm will also provide phone-based meetings with financial professionals, subject to availability and limited to general education as opposed to individualized advice.
Nelson says this free support is intended to help individuals understand the CARES Act and the trade-offs involved in choosing among available financial resources: loans, hardship withdrawals, etc.
Empower Retirement is another provider that has announced efforts to help Americans contemplating taking hardship withdrawals. For starters, moving forward, the firm will not charge origination fees on any new plan loans and will suspend charges for all hardship withdrawals. These changes cover “all tax-qualified workplace retirement plans administered by Empower that permit such distributions.”
“We must do everything we can to accommodate the immediate financial needs of our customers,” says Empower Retirement President and CEO Edmund Murphy III. “Some are already in financial distress right now and need access to their retirement savings to support their loved ones. We are taking these steps to help those families.”
The fee waiver will remain in place until further notice, depending on circumstances in the economy and financial markets, Murphy says. He adds that Empower has “bolstered all call center capacity” and elevated the availability of one-on-one counseling sessions to meet the needs of retirement investors seeking advice.