By Allison Brecher, Vestwell's General Counsel
There is not much written about how retirement plan sponsors should weather situations like the one we’re facing now, mostly because these are unprecedented times. However, the virus that’s causing a meltdown on Wall Street shouldn’t create a meltdown in your office. Knee-jerk reactions like eliminating all equities or terminating a plan altogether can have far reaching consequences. While the ideal outlook is to stay the course, we recognize that not all companies are in the position to do so. So what are the most effective options for sponsors looking to their 401(k) or 403(b) plans as a way to manage costs?
While staying the course is often the best route in times like these, that’s not necessarily an option for all companies. In instances where short term cash flow is imperative to survival, there are a number of options as it relates to company retirement plans.
Federal law recently gave states flexibility to provide unemployment benefits in multiple scenarios related to COVID-19. For example, states can now pay benefits where the employer temporarily ceases operations due to the virus, an employee is quarantined with the expectation of returning to work after the quarantine is over; and an employee leaves employment due to a risk of exposure or to care for a family member. Depending on your state, it may be possible and preferable to place an employee on a leave of absence, rather than terminating their employment. During this time, employees remain plan participants, but cannot make deferrals since they will not be receiving a paycheck. This may be an ideal solution for employers who intend to rehire these same employees after the crisis period ends. It also avoids the problem of the plan potentially becoming subject to partial termination rules, which would occur when a significant number of employees are separated from employment. A partial termination would require immediate full vesting and distribution of balances for all severed employees, and could otherwise be more expensive for the sponsor.
A plan termination can seem simple at first glance, but it’s anything but. In order to shut down a plan entirely, all balances must be 100% immediately vested which means a sponsor is often paying out company matches earlier than anticipated. Because the plan must promptly distribute all assets, loans must be repaid immediately, potentially creating further hardship for participants. Additionally, sponsors must wait one year after fully terminating a plan before they can start a new one, opening up hiring, retention, and tax implications down the road. Lastly, it’s important to note that termination may not be an option for all plan sponsors (e.g. when other retirement plans are held or are part of a controlled group of related employers) so it’s imperative to understand plan design.
Instead of a full termination, sponsors can consider a less expensive approach of a partial termination. This generally occurs when an employer terminates a significant percentage of employees, usually about 20% of headcount, or amends the plan to reduce benefits significantly. It’s a facts and circumstances approach and, while it would still require immediate full vesting and distributions to affected participants, it can be less onerous on the sponsor than a full termination.
Some sponsors pay for plan expenses out of the sponsor’s corporate assets. If a plan provider agrees to a bill delay, it could soften the impact during times of crisis. Alternatively, since the decision of whether to pay for plan expenses is a fiduciary decision made by the sponsor, the sponsor that is paying most of the plan-related expenses from corporate assets can shift that burden to the Plan.
For some plans, employers may be able to suspend the employer match or profit sharing contribution for up to three years without terminating the plan. For most plans where the employer match is completely discretionary, this is a fairly simple solution that can quickly reduce costs, especially given that most employee matches are between three to six percent. There is no advance notice required and the employer is free to eliminate contributions immediately. For safe harbor plans, however, employers must provide eligible employees with notice, the plan must be amended, and the change takes effect 30 days after the notice is delivered or the plan is amended (whichever is later). The plan must also still satisfy certain compliance testing requirements and participants must be given an opportunity to reduce their deferrals knowing they may not receive a previously expected employer match. With respect to the nonelective contribution, the employer may need to demonstrate a business hardship or economic loss to the IRS.
Subject to certain limitations, plans may be amended in the middle of the plan year to help sponsors reduce costs. For instance, a plan can be amended to extend the required service period for employees who are not already eligible to participate, thus saving costs. While not always legally required, notice should be provided as soon as possible in order to maintain good will between employees and the employer and to comply with fiduciary responsibility rules under ERISA. Employees may still be upset, but a timely, clearly written notice provided as far in advance as possible might help alleviate their disappointment.
Defined contributions plans, such as cash balance plans, can be frozen, which can help reduce a sponsor’s financial obligations in the short-term. Profit sharing plans that do not have any employee deferrals can also be frozen. The frozen plan still remains subject to compliance and minimum funding requirements, but it gives sponsors flexibility regarding plan operations. A plan can either be fully frozen, where all benefit accruals for all participants cease, or sponsors can implement a so-called “soft freeze” option that stops benefit accruals for some employees based on age, tenure, or job classification.
Regardless of which approach makes the most sense, plan sponsors should remember that they’re still fiduciaries who need to act in the best interests of their plan and its participants. Therefore, plan terms must be reviewed carefully before any action is taken and employees should be made aware of any changes. By exploring options and selecting the least disruptive — yet effective — measure, we can try to maintain some sense of stability during a time that is anything but.
Vestwell is not a law firm or tax advisor and we do not offer legal, tax, or investment advice. You may wish to consult your own financial or legal advisor before making any decisions regarding your retirement plan or any distributions.