Faced with the unprecedented effects of the coronavirus (COVID-19) pandemic on the workforce, business operations, and the global economy, employers and employees are looking for ways to cover medical costs, pay bills and reduce costs. In addition to approved and proposed Congressional relief, the Internal Revenue Service and Department of Labor have issued guidance to grant additional relief to employers and employees alike.
As this guidance continues to be released and legislation continues to be proposed and enacted into law, it is important for employers who sponsor 401(k) plans or other tax-qualified defined contribution plans to understand critical stress points and administrative issues that will likely arise as sponsors and participants face these uncertain times.
We are already seeing, and expect to see more, employers reducing or suspending employer matching, nondiscretionary, or profit sharing contributions to their 401(k) plans. For non-safe harbor plans, employers have a great deal of flexibility to reduce or discontinue matching or non-elective contributions. Generally, non-safe harbor plans that specify a certain matching or non-elective contribution formula can be amended at any time to reduce or suspend these employer contributions prospectively, although participants are still entitled to any contributions they have earned under the terms of the plan prior to the amendment. For plans that permit entirely discretionary employer contributions, a plan amendment may not be necessary, although we do recommend formal employer approval (i.e., a board or committee consent) to document the change.
On the other hand, safe harbor contributions can be suspended only if the employer is operating at an economic loss for the plan year, or if the annual safe harbor notice provided to participants before the start of the current plan year contained a disclosure that the employer might reduce or suspend the safe harbor contributions. To suspend safe harbor contributions, the employer must also take the following steps:
- The employer must provide a notice to employees at least 30 days before the change is made, explaining that the safe harbor contributions are being reduced or suspended.
- The employer must amend the plan to provide for the reduction or suspension of these contributions prior to the effective date of the change. The employer is still obligated to pay any contributions earned under the terms of the plan prior to the effective date.
- Because the plan loses its safe harbor protections, the employer will be required to perform ADP, ACP, and top heavy testing for the plan for the entire plan year.
Although workforce changes and personal circumstances may result in reduced elective contributions to 401(k) plans, it is important to also note that the current crisis does not reduce plan sponsors’ fiduciary obligations with regard to depositing employee contributions. Employers should make sure, whether implementing furloughs or layoffs, adapting to having employees work remotely, or operating under tightened budgets, that any employee contributions withheld are timely remitted to the plan. Those contributions are considered plan assets as soon as they can reasonably be segregated from the employer’s general assets, and failure to timely separate contributions from the employer’s general assets could result in excise taxes, penalties, and other additional costs to the employer.
Additionally, to the extent any leave of absence is paid or partially paid or in the event of layoffs, employers should be mindful to properly apply the plan’s compensation definition for purposes of employee deferrals. For example, paid time off is generally considered plan compensation, while severance pay is not.
Plan Loans and Distributions
Employers are likely to see increased interest from participants in taking loans or other in-service distributions from 401(k) plans, so it is important to understand what options are permitted under their plans, and the requirements that must be met to allow those distributions.
- In-Service Distributions. Some plans permit in-service distributions once participants reach age 59½.
- Hardship Distributions. Some plans permit hardship distributions to employees under limited statutory circumstances that constitute an “immediate and heavy financial need,” including medical costs, payments required to prevent eviction or foreclosure, or costs attributable to qualifying federal disasters (the COVID-19 pandemic has been declared a qualifying FEMA disaster in only a few states at this point). Some plans also permit a “facts and circumstances” analysis to permit distributions for hardships other than the statutory list.
- Loans. Some participants may opt to take loans instead of distributions. Loans must be expressly permitted under the plan, and the employer will likely have a separate loan policy in place that would govern the terms of loans from the plan. Loans are limited to $50,000 or 50% of the participant’s vested account balance, whichever is less.
Plan loans or in-service distributions must be expressly permitted by the plan, and the plan will likely outline any requirements or limitations applicable. If the plan does not expressly provide for loans or distributions, the employer can generally amend the plan at any time to permit them. Employers may also be able to expand the availability of distributions or loans already available under their plans, but should seek legal counsel to ensure any expansion would be permitted under the law. For example, for furloughs, applicable tax laws permit suspension of plan loan repayment for up to one year, and the loan can be reamortized over the original term once the employee returns to work. In addition, legislation has been proposed to increase the availability of certain distributions and loans to participants during this crisis, so the employer may have additional options as new legislation continues to pass.
Crediting Employee Service and Partial Plan Terminations
401(k) plan sponsors having to furlough and lay off employees should consider how such actions will impact plan benefits, and may want to consult with legal counsel to ensure all potential issues and costs are considered. A furlough is typically not considered a termination from service, so furloughed employees may continue to accrue vesting service or even additional benefits under the plan while on furlough or other approved but unpaid leave. Employers should review plan provisions regarding service when considering placing employees on furlough or unpaid leave.
On the other hand, plan sponsors making layoffs or reductions in force should note that an involuntary turnover of 20% or more plan participants creates a presumption that there has been a partial plan termination. If a partial plan termination has occurred, all impacted employees will become fully vested in their entire account balance.
Investment Options Under Plan
Plan sponsors must continue to review and monitor the investment options offered under their plan during this time. Plan investment fiduciaries and committees should continue to have meetings (by teleconference or video conference, as necessary) with their investment advisors to discuss the investments offered to plan participants.
For assistance navigating issues related to COVID-19, please reach out to the MMM Employee Benefits & Executive Compensation Team.