Under IRS Notice 2020-50, employers sponsoring nonqualified deferred compensation plans (NQCD plans) may now allow employees to suspend their deferral elections without having to determine whether the employee has had an unforeseeable emergency for purposes of Section 409A or otherwise qualifies for a hardship under Section 401(k) if the employee received a coronavirus-related distribution from an eligible retirement plan.
The ongoing coronavirus (COVID-19) pandemic has greatly affected many employers and their employees. Employers sponsoring NQCD Plans are seeing an increase in requests from NQDC Plan participants to suspend deferral elections in order to deal with financial hardships resulting from COVID-19.
The existing rules under Section 409A of the Internal Revenue Code of 1986, as amended (the Code) and the related regulations (Section 409A) permit NQDC Plans to allow for the cancellation of deferrals if a participant has an “unforeseeable emergency” under Section 409A or takes a “hardship” distribution as defined under Section 401(k) of the Code and the related regulations (Section 401(k)). The deferrals to the NQDC Plan must be cancelled, and not merely postponed or delayed, and any subsequent deferral election must be treated as an initial election to defer.
The wrinkle until now for many NQDC Plan participants affected by COVID-19 has been meeting the relatively strict qualifications for “unforeseeable emergency” or “hardship” under the existing IRS rules. To have an unforeseeable emergency under Section 409A, an individual must have a severe financial hardship resulting from specific situations such as an illness or accident of the individual or the individual’s spouse or dependent, loss of property due to casualty, imminent foreclosure of or eviction from a primary residence; medical and prescription drug expenses, funeral expenses, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the individual’s control.
Similarly, to have a hardship under Section 401(k), an individual must have an immediate and heavy financial need to cover specific expenses such as expenses for medical care incurred by the individual or the individual’s spouse or dependent, costs (other than mortgage payments) related to the purchase of a principal residence, payment of tuition and educational expenses, payments needed to prevent eviction from or foreclosure on a primary residence, burial or funeral expenses, or certain expenses relating to the repair of damage to a principal residence due to casualty.
IRS Notice 2020-50 makes it easier for participants in NQDC Plans to suspend their deferral elections if they have been affected by COVID-19 but would not meet the requirements for an “unforeseeable emergency” or a “hardship” as determined under the existing IRS rules. Under IRS Notice 2020-50, if a service provider receives a distribution from an eligible retirement plan (such as an individual retirement account or annuity (IRA), 401(k) Plan, 403(b) Plan and 457(b) Plan) that constitutes a “coronavirus-related distribution” under the IRS rules, that distribution will be considered a hardship distribution for purposes of Section 401(k) and Section 409A. As a result, a NQDC Plan may provide for a cancellation of a service provider's deferral election, or such a cancellation may be made, due to a coronavirus-related distribution.
An individual may qualify for a coronavirus-related distribution from an eligible retirement plan if the individual (or the individual’s spouse or dependent) has tested positive for COVID-19 using a CDC-approved test (including a test authorized under the Federal Food, Drug, and Cosmetic Act. An individual may also qualify for a coronavirus-related distribution if the individual has experienced adverse financial consequences because, due to COVID-19, the individual, the individual’s spouse, or a member of the individual’s household was quarantined, furloughed, or laid off, or had work hours reduced; was unable to work due to lack of childcare; had a reduction in pay (or self-employment income); had a job offer rescinded or start date for a job delayed; or had a business that they owned or operated close or reduce hours. Notably, an individual who qualifies for a coronavirus-related distribution does not have to demonstrate financial need for the funds and the amount of the distribution does not have to be limited to or correlate to the need arising from COVID-19.
A plan sponsor that would like to allow participants who have received coronavirus-related distributions to suspend deferral elections under the nonqualified deferred compensation plan should review the plan to determine whether an amendment is required in order to take advantage of this relief.