Waiver of 10% Early Withdrawal Penalty

Good morning to all,

Is it your understanding that the 10% early withdrawal on distributions made from a 401(k) plan has been waived for all withdrawals across the board for anyone making a withdrawal in 2020, or is it your understanding that this break on the 10% penalty is only available for CARES Act related distributions (CRDs), which in turn is only available if the employer has chosen to adopt the CARES Act distribution provisions for the plan?

Your advice is always greatly appreciated.

The waiver of the 10% penalty is to anyone who takes a taxable distribution from a covered account, up to first $100,000 if they have been affected by a Corona Virus related event. The scope of those events and who qualifies was greatly expanded last week by the 2 IRS Notice providing additional guidance on CARES ACT loans and distributions.

The taxpayer can claim the exemption on their tax return (I forget which Form is attached to the 1040) if the Plan has not adopted CARES Act provisions.

@ Lou S.  Thank you for the reply.  We need to be very sure we understand exactly how this works.  Half of our people think that it applies to all distributions taken in 2020 no matter what the circumstances might be.  Half of our people think the employer has to adopt the CARES Act provisions and the person taking the distribution has to fill out a specific CARES Act form (from John Hancock or American Funds for example) in order to get the waiver of the 10%.

If I am understanding you, the truth is in the middle between these two extremes.  You are saying that whether or not the employer chooses to adopt the CARES provisions and whether or not the employee is using a specific CARES form at the time of withdrawal, the real test comes when the employee gets his tax return done next spring.  At that time, he files an extra form to go along with his 1040 upon which he presumably is affirming that he was impacted in some way by COVID-19 and gets the 10% waiver?

Plan adopting the CARES provisions allows the following wrt distributions if the participant self certifies eleigibility-

1 - allow distributions that might not otherwise be available under the plan until 12/31/20

2 - no required withholding at the source of distribution.

3 - I'm not 100% certain on this but you can report Code 2 - exception to the early withdrawal penalty on the 1099-R

Here is a pretty good overview from the IRS https://www.irs.gov/newsroom/coronavirus-related-relief-for-retirement-plans-and-iras-questions-and-answers

You can also see IRS Notice 2020-50  https://www.irs.gov/pub/irs-drop/n-20-50.pdf 

12 minutes ago, ldr said:

You are saying that whether or not the employer chooses to adopt the CARES provisions and whether or not the employee is using a specific CARES form at the time of withdrawal, the real test comes when the employee gets his tax return done next spring.  At that time, he files an extra form to go along with his 1040 upon which he presumably is affirming that he was impacted in some way by COVID-19 and gets the 10% waiver?

 

The 10% waiver applies to a coronavirus-related distribution.  The list of factors that make a distribution a CRD was expanded by Notice 2020-50, but it is still a bit more than "impacted in some way".

Factors in CARES

(ii) to an individual—

(I) who is diagnosed with the virus SARS– CoV–2 or with coronavirus disease 2019 (COVID– 19) by a test approved by the Centers for Disease Control and Prevention,

(II) whose spouse or dependent (as defined in section 152 of the Internal Revenue Code of 1986) is diagnosed with such virus or disease by such a test, or

(III) who experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off or having work hours reduced due to such virus or disease, being unable to work due to lack of child care due to such virus or disease, closing or reducing hours of a business owned or operated by the individual due to such virus or disease, or other factors as determined by the Secretary of the Treasury (or the Secretary’s delegate).

Factors added in Notice 2020-50

an individual who experiences adverse financial consequences as a result of:
• the individual having a reduction in pay (or self-employment income) due to COVID-19 or having a job offer rescinded or start date for a job delayed due to COVID-19;
• the individual’s spouse or a member of the individual’s household (as defined below) being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19, being unable to work due to lack of childcare due to COVID-19, having a reduction in pay (or self-employment income) due to COVID-19, or having a job offer rescinded or start date for a job delayed due to COVID-19; or
• closing or reducing hours of a business owned or operated by the individual’s spouse or a member of the individual’s household due to COVID-19.

For purposes of applying these additional factors, a member of the individual’s household is someone who shares the individual’s principal residence.

Whether the employer elects to offer CRDs does not impact the final tax treatment for the participant, but CAN impact withholding on a plan level.  If plan sponsor does not elect to offer CRDs, John Hancock (and other platforms) will withhold 20% as usual.  Participant will file Form 8915-E with the 2020 return.  The 8915 is what tells the IRS that the distributed amount is subject to the waiver of the 10% penalty and 3 year taxation.  Whether the 1099-R says code 1, 2, or 7 doesn't matter, the 8915 is what will be important for the taxpayer.

22 minutes ago, ldr said:

Half of our people think that it applies to all distributions taken in 2020 no matter what the circumstances might be.

Only if the participant is a qualified individual.

23 minutes ago, ldr said:

Half of our people think the employer has to adopt the CARES Act provisions and the person taking the distribution has to fill out a specific CARES Act form (from John Hancock or American Funds for example) in order to get the waiver of the 10%.

10% penalty waiver applies regardless.  You will need to adopt CRDs and fill out a special form for the platform to withhold as a CRD.

@RatherBeGolfing:  Thank you very much for expanding on what had been said earlier.  I think all the pieces fall into place now.  

I agree with Lou S and Rather Be Golfing.  However, if you "need to be very sure we understand exactly how this works," I doubt that relying on Internet message board posters fulfills your need!