Consulting Through Uncertain Times: Retirement Plan Issues During COVID-19 Pandemic
As we continue our journey through the uncharted waters of the coronavirus pandemic, plan sponsors look to their advisors for guidance with respect to adapting their retirement plans to the events of the last few weeks and what lies ahead. Retirement plans are increasingly viewed as a potential source of financial stability for participants; at the same time, as they work to stabilize their businesses, employers grapple with funding decisions, cashflow planning, and long-term viability of retirement savings programs. Here are some ways you can prepare to help plan sponsors address some of the issues impacting retirement plans:
Plan Funding – Economic uncertainly may cause companies to revise their plan contributions formulas, amounts and types; to assess flexibility:
- Understand all employer contribution types currently provided by the plan, which are discretionary (e.g. discretionary match or profit sharing) and which may require an amendment for a reduction or suspension to take effect (e.g. safe harbor non-elective contribution, safe harbor match, fixed match or fixed profit sharing, or money purchase plan contribution).
- Understand service requirement for allocation of contribution or benefit accrual to implement a timely amendment to modify plan formulas and/or avoid violation of anti-cutback rules that prohibit reduction in benefits already earned.
- Understand special notice requirements that come into play with reduction or termination of certain contribution types, their timing, and distribution methods.
- Communicate impact of changes to contributions on compliance testing – elimination or reduction or safe harbor 401(k) match or non-elective contribution still requires those contributions to be made up to the effective date of amendment, brings back testing for deferrals and match (which will limit amounts highly compensated employees may defer), and may require additional contributions if a plan is top-heavy. For defined benefit and cash balance plans, formula freezes may not eliminate the need to fund the plan on the basis of benefits accrued before the freeze is effective.
- Communicate tools available to manage impact of plan asset drops due to market volatility on defined benefit and cash balance plans. Funding rules allow plan sponsors to spread any shortfall in plan assets over a period of up to 7 years softening the impact on required funding amounts; wherever feasible, excess contributions for 2019 may be treated as a prefunding balance to help offset 2020 asset shortfalls; freezing new benefit accruals is another possible tool to help with management of funding future benefits ( such freeze needs to be put in place before the first eligible participant works enough hours in the year to accrue a benefit, usually April-May timeframe for calendar year plans).
- Keep a close eye on legislative relief such as extensions for required contribution deadlines, temporary suspension of required contributions for 2020, and possibly longer periods to amortize shortfalls in plan funding.
Withdrawals and Loans – As more participants are likely to consider their retirement account balances to bridge income gaps or in light of new unexpected expenses:
- Understand the types of plan withdrawals available based on employer’s retirement plan document, their specific terms, and impact of employment status on eligibility for disbursement types (paid v. unpaid leave, layoff, reduction in scheduled hours v. layoff with termination)
- As hardship distributions come to focus, it’s important to understand that – subject to legislative intervention – hardship withdrawals are not permitted for reasons such as furlough or reduction pay due to reduction in scheduled hours, however they are available to provide for medical expenses for plan participant and/or beneficiary as well as to prevent foreclosure on the primary residence or eviction.
- Decide whether expansion of sources available for in-service distributions (such as vested match or profit sharing) and/or addition of other permitted in-service distributions may be warranted – e.g. permitting participants to access funds that have been in the plan for at least 2 years or after at least 5 years or participation in the plan.
- Review plan loan policy, if loans are allowed, to see how it addresses loan repayments while on paid and unpaid leave. Consider whether relaxing the loan policy may be of value – plans may permit multiple loans, IRS permits loan repayments to be paused while employee is on a leave of absence up to a year subject to certain additional requirements, and severance pay may be used for loan repayment purposes.
- Recall a recent law change impacting loans that go into default: former employees with defaulted loans can repay those amounts to an IRA. This option allows a terminated participant to repay the loan back directly to their IRA account until the due date of the tax return for the year of the loan default. For example, if the loan default occurs in 2020, the due date would be April 15, 2021 or October 15, 2021 with a filed extension. This approach helps avoid both the income tax and the early 10% withdrawal penalty.
- Watch for legislative action that may provide special coronavirus-related relief by expanding loan limits, waivers for 10% pre-mature distribution penalty, expanded loan or distribution repayment timeframes, i.e. actions patterned after 2009 relief legislation or recent hurricane and fire disasters.
Vesting – When furloughs and/or layoffs are contemplated, it’s critically important to understand impact of various employment scenarios (leaves of absence, layoffs, terminations) on vesting. In certain cases, complete discontinuance of contributions or termination of a certain percentage of employees may trigger full vesting for impacted participants. Employer’s specific facts and circumstances may be taken into account when the rule is applied, but historically the IRS and the Department of Labor tend to favor plan participants in these events.
Plan Compliance – With the far-reaching impact of COVID-19 pandemic, watch for possible extensions for deadlines to file Form 5500, take corrective actions for certain failed non-discrimination tests, and potential temporary relaxation of rules concerning required participant notices.
Coordination with Service Providers – As changes are contemplated, especially those relating to plan withdrawals, it is critically important to understand implementation timeframes and additional fees as a result of new and/or expanded plan features with plan’s investment platforms and other service providers.
Participant Communication – As various actions are considered, pay close attention to participant communication to make sure the changes are explained timely and in a manner easily understood by plan participants.
Plan Termination – Some plan sponsors may see plan termination as a way of managing through uncertain times. This reaction is completely understandable, and it may be the right thing in limited circumstances. That said, given the complexity, cost, and other challenges of termination (such as prohibition to implement a replacement 401(k) plan for 12 months), majority of those considering termination instead may be best served by elimination of non-discretionary contributions to provide maximum flexibility while allowing participants to take advantage of their retirement savings program to the best of their ability as markets and the economy stabilize. Should it be necessary, plan administration expenses may be paid out of plan assets.
We are actively monitoring retirement plan related developments and will continue updating you as more information becomes available.
For discussion purposes only and in no way represents legal or tax advice. For advice regarding your specific circumstances, the services of an appropriate legal or tax advisor should be sought.