Subscribe and download our eBook, "100+ Tax Deductions for Small Business A to Z."
Get the:

Questions and Answers

5 COVID-19-Related Questions for Your 401(k) Plan

Questions and AnswersIn response to statistics showing that only 53% of workers at companies with fewer than 100 employees were able to participate in a qualified retirement plan, the SECURE Act, which became effective on December 20, 2019, made changes to induce small businesses to offer plans. Toward this end, the new law expanded the existing tax credit for setting up a plan and added another credit for adopting an automatic enrollment plan. It’s unknown whether these tax incentives led any small businesses to adopt new plans for 2020. Nonetheless, new plans, as well as existing 401(k) plans, now find themselves in a COVID-19-created economy. In this new economy, many small businesses and their employees are struggling to survive, and those with 401(k) plans may have questions on what to do.

Here are 5 questions with answers that could influence decision-making for small businesses with 401(k) plans.

Do you have a partial termination?

If you lay off 20% of the plan’s participants in 2020, the plan is treated as having been partially terminated. This means that participants become immediately vested in all employer contributions (they’re already vested in their own contributions). This may not make much difference to the plan or to you. But if there were forfeitures, terminated employees may be owed more benefits and the employer may be responsible for making these former employees whole.

Can you stop making employer contributions?

If you’re experiencing cash flow trouble, you are permitted to reduce or suspend certain employer contributions to 401(k) plans. Determine whether you have this flexibility. Under a safe harbor rule, you can cut back or suspend certain employer contributions as long as you give a supplemental notice form to employees explaining your action and that they have the opportunity to change their elective deferrals for the rest of the year. This notice must be given at least 30 days before the change goes into effect.

How much can employees borrow from their accounts?

If the 401(k) plan allows participants to take loans (most plans do), then you can allow each to borrow up to $100,000 if their account balance is at least this much. If the account balance is less, then the maximum loan amount is capped at the account balance. Such loans are permissible through September 24, 2020. Thereafter, loans are capped at the usual of 50% of the account balance, but no more than $50,000. It’s up to the plan to decide whether to offer the increased loan limit.

Employees don’t have to provide the plan with the reason they need the loan. It doesn’t even have to be COVID-19-related.

Participants who have plan loans outstanding on March 27, 2020, can delay repayments due from that day through December 31, 2020, for up to one year. But interest continues to accrue during the suspension of repayments. This one-year delay period is ignored for purpose of the usual 5-year repayment period.

How long do employees have to replace distributions they’ve taken?

Plan participants who are impacted by COVID-19 can take a distribution of up to $100,000 through December 31, 2020. The distribution is taxable to them (the plan must issue Form 1099-R to report the taxable distribution). The distribution is not subject to the 10% early distribution penalty if the employee is under age 59½ as long as the distribution is COVID-related, which means a participant:

  • Is diagnosed with COVID-19
  • Has a spouse or dependent diagnosed with COVID-19
  • Experiences adverse financial consequences due to being quarantined, furloughed, laid off, having reduced work hours, or being unable to work due to lack of child care because of COVID-19
  • Is an owner of a business that is closing or reducing hours due to COVID-19
  • Is impacted by other factors set by the IRS (nothing in this regard has been done yet)

But employees can elect to spread the income over 3 years. Also, they have up to 3 years to replace the funds in their accounts if the plan allows for rollovers (most but not all do). The fact that they’ve taken a distribution does not impact their ability to continue to make salary deferral contributions to the plan or their eligibility for employer contributions to their accounts.

Do plan documents have to be amended to reflect law changes?

Yes. Documents can be amended immediately to reflect the law changes discussed above. But amendments aren’t required until the last day of the plan year beginning on or after January 1, 2022 (i.e., by December 31, 2022, for a calendar year plan). If you have a prototype plan—a boilerplate document—from the brokerage firm, mutual fund company, or other financial institution with which you maintain the plan, the burden is on them to update their documents and provide amended ones to you.

The amended documents should reflect the liberalized loan rules if you want to offer them to participants.

Final thought

Be sure to discuss your company’s intentions with respect to a 401(k) plan with your CPA or other benefits adviser to be sure you’re conducting the plan in accordance with new tax rules. Find more guidance in IRS FAQs.