By Pension and Benefits Editorial Staff
The Enhancing Emergency and Retirement Savings Act (S. 1870), as introduced by Senator James Lankford (R-OK) and Senator Michael Bennet (D-CO), would authorize a penalty-free distribution, of up to $1,000, from 401(k) plans and other employer-sponsored retirement accounts, as well as IRAs, to enable individuals to meet unforeseeable personal or family emergency expenses. Additional emergency withdrawals would be authorized, but only if the individual has recontributed the previous distribution back to the plan.
The bipartisan legislation has received support from several employee benefit advocacy groups.
Penalty tax on early distributions. A 10 percent penalty tax is imposed on an individual under age 59 ½ who receives a distribution from a plan qualified under Code Sec. 401(a), a 403(b) plan, or from an individual retirement arrangement (Code Sec 72(t)(1)). However, specified distributions are not subject to penalty. Among the distributions exempt from the penalty tax under Code Sec. 72(t)(2) are those made: to a beneficiary (or to the estate of an employee) after the employee’s death; because the employee is totally and permanently disabled; to an employee on account of medical expenses, to the extent that the expenses would be deductible under Code Sec. 213 (determined without regard to whether the taxpayer itemizes deductions); for qualified higher education expenses; or for “qualified birth or adoption distributions” of up to $5,000.
Hardship distributions are not exempt from penalty tax. The only exceptions to the penalty tax on early distributions are those authorized by Code Sec. 72(t)(2). Accordingly, 401(k) participants who receive a hardship distribution from the plan will be subject to penalty tax on the taxable amount of the distribution, unless one of the enumerated exceptions under Code Sec. 72(t)(2) is met.
Distribution for certain emergency expenses. The Act would amend Code Sec. 72(t) by authorizing emergency personal expense distributions (Code Sec. 72(t)(2)(I), as added by Emergency Act Sec. 2(a)). The emergency distribution would be subject to several conditions.
One distribution per year. Individuals would be limited to one emergency distribution per calendar year.
Dollar limit on distributions. The amount treated as an emergency personal distribution by an individual in any calendar year could not exceed the lesser of $1,000, or an amount equal to the excess of: (1) the individual’s total nonforfeitable accrued benefit under the plan (or the individual’s total interest in an IRA), determined as of the date of each distribution, over (2) $1,000.
Aggregate limit. The aggregate amount of emergency distributions from all plans maintained by the employer (and any member of the employer’s controlled group) could not exceed the applicable limitation (Code Sec. 72(t)(2)(I)(v), as added by Emergency Act Sec. 2(a)).
Emergency personal expenses. An emergency personal expense distribution would be defined as any distribution from an applicable eligible retirement plan (e.g., 401(k), 403(b), 457 plan or IRA) to an individual for purposes of meeting “unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses” (Code Sec. 72(t)(2)(I)(iv), as added by Emergency Act Sec. 2(a)). The plan administrator would be allowed to rely on an employee’s certification that the distribution would qualify as an emergency personal expense distribution.
Repayment of distribution. Individuals who receive an emergency personal expense distribution would be empowered, at any time during the three-year period beginning on the day after the date on which the distribution was received, to make one or more contributions, in an aggregate amount not to exceed the amount of the distribution, to an applicable eligible retirement plan of which the individual is a beneficiary and to which a rollover contribution may be made under Code Secs. 402(c), 403(a)(4), 403(b)(8), 408(d)(3), or 457(e)(16) (Code Sec. 72(t)(2)(I)(vi), as added by Emergency Act Sec. 2(a)).
Limitation on subsequent distributions. In the event a distribution is treated as an emergency personal expense distribution in a calendar year, the amount could generally not be treated as an emergency distribution in any subsequent calendar year (Code Sec. 72(t)(2)(I)(vii), as added by Emergency Act Sec. 2(a)). However, exceptions would be authorized if: (1) the previous distribution was fully repaid, or (2) the aggregate amount of the elective deferrals and employee contributions to the plan (the total amounts contributed to an IRA) subsequent to the distribution was at least equal to the amount of the previous distribution which has not been repaid.
Effective date. Emergency personal expense distributions would be available after December 31, 2021 (Emergency Act Sec. 2(b)).
Conclusion. The authorization of emergency personal expense distributions comes close to allowing individuals to treat their retirement accounts as personal savings account. However, the proposed restrictions on access, including the condition restricting subsequent withdrawals prior to the repayment of a prior distribution, may, as Senator Bennet suggests “give workers more flexibility to foot the bill for an unexpected emergency expense(s),” while, as Senator Lankford notes, “also ensuring that individuals continue to save for retirement.”
Significantly, the bipartisan legislation has drawn the support of: Nationwide Retirement Solutions, American Retirement Association, American Benefits Council, The ERISA Industry Committee (ERIC), State Street Global Advisors, and LPL Financial. Industry support seems to be based on the understanding, as expressed by Eric Stevenson, President of Nationwide Retirement Solutions, that the legislation would “give savers comfort that they’ll have access to their money in the event of an emergency” and “remove a significant barrier for low- and middle-income workers to save for retirement in the first place.”
The bipartisan support for the proposal in the Senate, coupled with industry backing, indicates that the proposal could be included in any legislation that emerges this Congressional session.
Source: The Enhancing Emergency and Retirement Savings Act (S. 1870).
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