Qualified retirement plans are a key component of financial security for owners and their employees. The SECURE Act in December 2019 and the CARES Act in March 2020 made significant changes in various rules related to retirement plans. Incentives for small businesses to adopt plans have increased and special rules related to COVID-19 have been put in place to enable employees to tap their accounts now. But taking advantage of favorable law changes requires owners to take action.
COVID-19 Actions for Existing Retirement Plans
Your company’s 401(k) or other retirement plan can be a source of financial help to employees that may be struggling as a result of the pandemic. The plan isn’t required but can permit qualified individuals to take COVID-1 distributions up to $100,000 (with special tax treatment for participants who take them) and loans up to $100,000 (with special rules for the suspension of loan repayments) from March 27, 2020, through December 31, 2020.
Follow the rules. The plan isn’t required to offer these COVID-19 incentives, but if it does, be sure to comply with tax rules. COVID-19 distributions means they are restricted to an individual, spouse, or dependent who is diagnosed with the disease, experiences adverse financial consequences as a result of the pandemic, or meets other specified conditions (defined by the IRS). Some things to consider:
- Understand the scope of the rules. For example, those who take distributions can repay them within 3 years. The plan administrator can accept the recontributions during this period only if the recontributions are eligible for direct rollover treatment (they were initially made as COVID-19 distributions as certified by the participant, which is explained later),
- Follow special reporting rules for Form 1099-R. Reporting is required even if funds recontributed. Instructions to this form explain new reporting requirements (instructions for the 2020 form are not yet available).
- Develop reasonable procedures for identifying when distributions are treated as coronavirus-related distributions. The plan administrator can rely on an individual’s certification that he or she meets the tests described earlier (there’s a sample acceptable certification form here).
- Follow certain basic rules. For example, when making a distribution from a pension plan, spousal consent is still required).
- Don’t withhold 20% on the distribution. That’s what the IRS says.
Make plan amendments. If the plan offers COVID-19-related distributions and loans, the plan must be amended to reflect this. The deadline for amendments is the last day of the first plan year beginning on or after January 1, 2022, so there’s plenty of time to act.
Mid-year Plan Changes
Typically, employers commit to their contributions to 401(k) plans at the start of the year. This can influence employees’ decisions on their salary reduction contributions. If the business is experiencing financial difficulties and can’t continue to make promised contributions for employees in 2020, the employer is allowed to make mid-year changes under certain circumstances. Under a safe harbor, certain notice to employees must be given to employees.
No Plan Yet? Consider One
If your business doesn’t have a qualified retirement plan, consider adding one. It is an important employee benefit for attracting and retaining valuable employees. And there are helpful tax breaks for employers and employees. For example, employers can deduct contributions to the plan, while employees who make salary reduction contributions are not currently taxed on the compensation used for this purpose. And employees may be eligible for a tax credit for their contributions.
Which plan to choose? There are many different types of options. Some are funded entirely by employers, some by employees (with optional employer contributions), and some with employee contributions along with certain employer-matching contributions. The plan you choose depends on many factors, including the size of your staff and what your company can afford. Find a comparison of retirement plan options in IRS Publication 3998.
Tax breaks for initiating plans. If you are a small business (defined as one with 100 or fewer employees who received at least $5,000 in compensation from you in the preceding year), you may qualify for one or both of the following tax credits as an offset to administrative costs.
- Startup plan. The tax credit for starting a plan that covers at least one participant who isn’t an owner or owner’s spouse is the greater of (1) $500 or (2) the lesser of (a) $250 for each employee eligible to participant who isn’t highly compensated or (b) $5,000. The credit can be claimed for up to 3 years. This credit replaces a much smaller credit that applied to a plan adopted before 2020. The credit can only be claimed if you didn’t have a plan for employees in the 3 years before the first year of the plan for which you’re claiming the credit.
- Automatic enrollment plan. If you start a plan that automatically enrolls eligible employees (who can still decide to opt out or reduce their contributions) or you convert an existing plan to automatic enrollment, you can take a tax credit of up to $500 per year for up to 3 years. This credit can be claimed in addition to the startup credit. It’s new starting in 2020.
When it comes to retirement plans, the opportunities are great, but the pitfalls are numerous and can easily lead to penalties and other problems. Because the subject of qualified retirement plans is highly complicated, be sure to discuss your situation with your CPA or a benefits advisor.