August 25, 2020

Warn Your Clients

Sponsors face hard choices about COVID-19 hardship withdrawals.

Reported by PLANADVISER staff

Art by Jackie Ferrentino

Robert Lawton, president of Lawton Retirement Plan Consultants, spoke to PLANADVISER about two provisions in the Coronavirus Aid, Relief and Economic Security (CARES) Act: the creation of coronavirus-related distributions (CRDs) and the doubling of the limit on plan loans.

PLANADVISER: Under the CARES Act, a CRD may be drawn in any amount up to $100,000. The normal 10% penalty tax is waived, and the individual taking the CRD may spread the reported income over three years for tax purposes. What else should plan sponsors understand right off the bat about CRDs and making them available to their participants?

Lawton: The CARES Act does not require plans to make this relief available. Thus, if a plan sponsor has a strong conviction that its plan population has not greatly suffered financial harm as a direct result of the pandemic, the prudent course of action is to refrain from permitting this new type of penalty-free hardship withdrawal.

You should also know that the CARES Act does not require participants who take these withdrawals to show evidence of financial hardship or loss, as would be required under normal hardship withdrawal provisions.

PA: Are there circumstances where drawing a CRD may seem appealing but will in fact come back to harm participants?

Lawton: Taking advantage of these provisions will generally not be in most participants’ best interest. First, even though participants have the option of paying these withdrawals back, the vast majority won’t. Second, a significant number of participants who withdraw up to $100,000 from their retirement plan accounts will destroy their chances of retiring with a sufficient balance.

And finally, the bankruptcy protections afforded to retirement plan assets should be considered. Any possibility that the participant would have to declare bankruptcy is critical to factor in when considering these withdrawals. Most participants are unaware that they can declare bankruptcy and protect their retirement savings.

PA: Is expanding plan loans a better idea for some, perhaps most, plan sponsors?

Lawton: If a sponsor feels it needs to provide greater employee access to plan balances, and its plan permits loans, it can adopt the CARES Act’s relaxed loan provisions instead of the withdrawal provisions. While I don’t favor 401(k) loans, they are better than withdrawals during this pandemic.