This Alert discusses certain considerations for tax-qualified retirement plan (in particular, 401(k) and 403(b) plan) sponsors and fiduciaries in light of business/market conditions, employee needs and law changes resulting from the COVID-19 pandemic. Please also refer to the McCarter Alert discussing the new relief provisions for employee benefit plans under the CARES Act, here.
Reducing Employer Contributions
The need for employers to reprioritize where to allocate corporate resources to sustain operations through the pandemic is forcing plan sponsors to consider reductions of employer contributions to defined contribution plans (such as 401(k) and 403(b) plans). Whether the plan will need to be amended to reflect a reduction of employer contributions depends on the terms of the plan and the type of contribution.
- Non-safe harbor nonelective and matching contributions. Where these contributions are discretionary under the terms of the plan, the sponsor generally does not have to amend the plan to reduce contributions. Where these contributions are required by the terms of the plan document (sometimes referred to as “fixed” contributions), the plan document will need to be amended to reduce contributions. While there is generally no advance notice requirement under tax rules for reducing non-safe harbor contributions to 401(k) and 403(b) plans, sponsors should give employees the opportunity to change their deferral elections before the reduction takes effect (particularly in the case of matching contributions).
- Safe harbor 401(k) and 403(b) nonelective and matching contributions. Generally, safe harbor contributions need to remain in place for the entire year, but can be reduced by plan amendment if either:
– The sponsor is operating at an “economic loss” (as defined under IRC § 412(c)(2)(A)); or
– The sponsor included the possibility of contribution suspension or reduction in the required annual safe harbor notice.
To utilize either exception for reducing safe harbor contributions, (i) employees must be provided a supplemental notice informing them of the reduction, (ii) the reduction cannot be effective earlier than 30 days after eligible employees are provided the notice, (iii) the amendment must be adopted before the effective date of the reduction, (iv) employees must be given a reasonable opportunity after receipt of the notice to change their elective contributions, (v) the plan must satisfy the safe harbor requirements with respect to compensation paid through the effective date of the reduction, and (vi) the plan must be amended to provide that the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests will be satisfied for the entire plan year. For plans using safe harbor nonelective contributions, the 2019 SECURE Act eliminated the need to provide the annual safe harbor notice, so more IRS guidance is expected as to the notice requirements for reducing nonelective contributions midyear. For the time being, sponsors should generally provide the 30-day advance notice.
In-Service Access to Benefits
Due to the recently passed relief packages, plan sponsors can offer participants multiple options to access their retirement plan accounts while still working:
- Coronavirus-related distributions. Under the CARES Act, a participant can take an in-service “coronavirus-related distribution” during 2020 of up to $100,000 maximum per individual (across all plans of a controlled group), and the 10% early withdrawal penalty that usually applies for distributions before age 59 ½ is waived. To be eligible, a participant must be either diagnosed with COVID-19 by a test approved by the CDC, have a spouse or dependent who is diagnosed with COVID-19, or experience adverse financial consequences as a result of being quarantined, furloughed or laid off; having work hours reduced; being unable to work due to lack of child care due to COVID-19; closing or reducing hours of a business owned or operated by the individual due to COVID-19; or other factors as determined by the Treasury Secretary. Please refer to our separate CARES Act Alert, here.
- Plan loans. The CARES Act also increases qualified plan loan limits for participants who qualify for the coronavirus-related distribution. Under the new relief provisions, a qualified individual can take a plan loan within 180 days of March 27, 2020, of up to the lesser of either $100,000 or 100% of the individual’s vested account (reduced by the excess of his or her highest outstanding loan balance during the preceding one-year period over his or her outstanding balance on the date of the loan). Please refer to our separate CARES Act Alert, here.
- Hardship distributions. In addition to the two options above, a participant affected by the COVID-19 pandemic may also take an in-service distribution under the regular hardship provisions commonly available under most plans, subject to normal plan rules and legal requirements (including the potential application of the 10% early withdrawal penalty that generally applies to hardship distributions).
Under the normal hardship rules, a participant can request a distribution due to an immediate and heavy financial need, limited to the amount necessary to satisfy that financial need. An individual is deemed to have an immediate and heavy financial need if the distribution is for any of the following regulatory “safe harbor” reasons, which can, but need not be, COVID-19-related:
- Expenses for certain medical care of the participant or primary beneficiary;
- Costs directly related to the purchase of a principal residence for the participant (excluding mortgage payments);
- Payment of certain postsecondary tuition and related expenses of the participant or primary beneficiary;
- Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence;
- Payments for burial or funeral expenses for the employees deceased parent, spouse, child or dependent, or for a deceased primary beneficiary under the plan;
- Certain expenses for the repair of damage to the employee’s principal residence; or
- Expenses and losses (including loss of income) incurred by the employee on account of a disaster declared by the Federal Emergency Management Agency (FEMA) under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, Public Law 100-707, provided that the employee’s principal residence or principal place of employment at the time of the disaster was located in an area designated by FEMA for individual assistance with respect to the disaster.
As to the disaster area safe harbor, FEMA has declared all 50 states as major disaster areas and has designated certain states (including, among others, New York and New Jersey) eligible for certain individual assistance. This means that employees who live or work in those states (or other states that may be so designated under future FEMA announcements) who experience a financial hardship in connection with the COVID-19 pandemic (due to salary reduction, furlough, reduction in hours, business shutdown, etc.) may be eligible to take a hardship withdrawal under this safe harbor. Notably, a mere salary reduction is not a basis for taking a COVID-19 distribution under the coronavirus-related distribution provision summarized above but may be a basis under this option. Sponsors should be aware that the FEMA disaster area safe harbor applies only to cover expenses and losses of an employee and not the employee’s relatives and dependents, and that there is no specific deadline by which a participant must submit a request for a disaster-related hardship distribution.
Some plans limit the number of hardship distributions to one or two during a plan year or any 12-month period. Sponsors may consider amending their plans to increase the number of hardships available under the plan.
Sponsors should keep in mind that adding to or supplementing in-service distribution options will likely increase plan administrative burdens and the potential for operational errors (see below regarding vendor management), and will require timely plan amendments. Also, while the ability to access funds while in time of need may be critical to some participants, the depressed market may mean that participants will be “cashing out” at significantly reduced investment values; sponsors should consider the extent to which participants are sufficiently educated in this regard.
A Note About Furloughed Employees
Many sponsors have implemented or are considering implementing a furlough program (i.e., temporary unpaid leave) due to the COVID-19 pandemic. Furloughs raise unique issues in regard to plan administration, a few of which are highlighted below. Sponsors must review their plan documents and understand exactly what the implications of a furlough are under the particular terms of the plan.
Loan repayments. In general, an employee on furlough can suspend making loan payments, but only if the furlough period is less than one year and the loan is satisfied within the original loan term. Under the CARES Act, however, a participant (including a furloughed employee) who is a qualified individual and has any loan payment due before December 31, 2020, can delay the payment and the original loan term for up to one year (with subsequent payments adjusted to reflect the delay in the due date and any interest accrued during such delay). Further, under recent IRS Notice 2020-23, the payment date for any loan payment that is due between April 1, 2020, and July 14, 2020, is extended to July 15, 2020 (regardless of whether the participant is a qualified individual under the CARES Act). As an alternative to or following a loan suspension, a sponsor may also arrange to have furloughed employees continue to make loan payments to the plan directly by check or electronic funds transfer.
Service crediting. For a plan that counts hours of service for purposes of benefit accrual, eligibility, vesting and employer contribution allocations, a furloughed employee generally will not be credited with service during the furlough period. For a plan that uses the elapsed time method, the furlough period (depending on its duration) likely would be counted.
Distributions. A furloughed employee generally is still considered an employee for qualified plan purposes and is therefore not eligible to take a distribution on account of a severance from employment. A furloughed employee may, however, be able to withdraw funds to the extent the plan offers loans, hardship withdrawals, or age 59 ½ or other in-service distributions. Sponsors need to appropriately reflect an employee’s furlough status in plan records to ensure that the plan (including its vendors) does not improperly process a distribution and subject the plan to disqualification.
Monitoring Plan Investment Performance
Plan sponsors and fiduciary committees should not lose sight of the fact that they have a continued duty to monitor plan investment performance (including the performance of investment advisors and managers) and plan fees. Plan fiduciaries should be consulting with investment professionals to understand how the recent volatility in the market affects their plans. For example, will a significant reduction in plan assets due to investment performance or plan distributions affect the fees that apply to the plan? Did any particular funds get “hit” hard relative to fund benchmarks, and should they be placed on a watch list? While not much can be done at this point regarding past investment performance (and not many people would have predicted current market conditions), fiduciaries need to demonstrate prudence going forward by adhering to investment committee guidelines and potentially enhancing their procedures. For example, prudence may call for holding an immediate special fiduciary committee meeting rather than waiting until a regularly scheduled meeting that is weeks or months away. As always, fiduciaries need to document the process and the basis for decisions.
Vendors are inundated with client servicing capacity issues and, as with their plan sponsor clients, are dealing with staff shortages and the switch-over to a remote workforce. The surge in plans needing COVID-19 and hardship distribution processing, loans, and changes in plan features may mean longer lead times and backlogs. Plan sponsors should be proactive in reaching out to plan service providers to understand how vendors are adjusting to the widespread business operation disruptions and how vendors can accommodate the specific needs of the plan sponsor (e.g., implementation and monitoring of the new COVID-19 distribution and loan relief). Further, sponsors should confirm that vendor participant education and any investment advisory offerings meet with market standards and that participants are being appropriately informed of the services available to them.
Workforce Reductions and Partial Plan Terminations
A substantial reduction in a plan sponsor’s workforce can result in a partial plan termination. Typically, a partial plan termination occurs when there is a reduction in active plan participation (e.g., due to layoff) of at least 20% during a year (or potentially a longer period — for example, if there is a series of related layoffs). Whether a partial plan termination has occurred is determined based on the facts and circumstances, including the extent to which terminations during the applicable period were voluntary, historical employee turnover rates, and whether separate instances of workforce reductions are part of the employer’s coordinated plan.
If a plan is partially terminated, all affected participants (generally, those who have been laid off) during the applicable period must be fully vested. Even affected participants who were severed from employment prior to the point at which the plan sponsor identified that the partial plan termination had taken place must receive full vesting. In that case, the plan sponsor may need to restore previously forfeited balances and locate former participants to inform them of the restored balances. To the extent forfeited assets have been used for other purposes (e.g., reducing employer contributions or paying plan expenses), the employer will be responsible for making the affected participants whole.
Employees who are temporarily furloughed and ultimately resume active participation in the plan after the furlough ends (particularly, if they resume active participation before the end of the plan year) generally would not be considered affected participants.
Since a partial plan termination is generally determined at or after the end of a plan year, the plan sponsor should continue to apply the current vesting schedule to midyear distributions but closely monitor the plan’s status as the implications of the COVID-19 pandemic upon the sponsor continue to unfold.
IRS Plan-Related Deadline Extensions
Due to the President’s national Emergency Declaration in early March in response to the COVID-19 pandemic, the IRS has issued a series of relief notices extending various tax deadlines. The most recent guidance, Notice 2020-23 (issued on April 9), extends important deadlines relating to employee benefit plans (including the loan payment extension until July 15, 2020, discussed above). Please refer to our separate Deadline Relief Alert for further details, here.