COVID-19: So many questions for employers about their 401(k) plans

COVID-19 is causing the retirement plan world to rapidly change and keeping up with the pace is challenging.

  • Are 401(k) savings plans facing “partial plan terminations”?
  • What will happen with 401(k) safe harbor plan contributions?
  • Can employer matching contributions be suspended?

The questions are coming from all sides and even showing up on page 1 of the Wall Street Journal. Not every situation has a clear-cut answer, let alone the right answer.

What about partial plan terminations? “Partial termination” is a term in the tax code. It means there has been more than a 20% reduction in an employer’s workforce due to unforeseen business circumstances causing financial issues or a business downturn during the year. It results in 100% vesting of retirement benefits for those employees affected, meaning the employees who lost their jobs.

The current economic environment is causing financial difficulties for businesses across all industries, and we are starting to see some 20% or more reductions of staff in workforces. Partial terminations are based on facts and circumstances as well as the time period of economic difficulty. If the business is able to successfully weather the financial downturn, rebuild its business, and hire and rehire more staff, then there is not a partial termination. If over the next year a business is not able to recover, and more employees lose their jobs, then we might assume there is a partial termination and 100% vesting for terminated participants applies.

What about the required 401(k) safe harbor contributions? How can employers continue these contributions if they are facing financial difficulties? As in past adverse business conditions, employers should be able to suspend the safe harbor match or the safe harbor nonelective contribution midyear but only if one of these two conditions is met:

  1. The employer is operating at an economic loss for the plan year.
  2. The notice provided at the beginning of the 2020 plan year includes a statement that the employer may reduce or suspend the contribution midyear.

If one of these two conditions is met, then the employer provides a supplemental notice at least 30 days before the effective date of the suspension, which then allows employees to have a reasonable opportunity to change their deferral elections before the suspension.

Administratively it is more work for the employer to make this change midyear. The 401(k) plan has to complete its actual deferral percentage (ADP) testing for the entire year using the current testing method. This may result in test failures and refunds of employee contributions.

If the employer contributions are discretionary, then the employer is not required by any regulation to make a contribution nor is there a mandatory participant disclosure requirement about the suspension. In addition, there is no plan amendment needed to discontinue the contribution.

If the employer contribution is defined in the plan document, then employers must ensure that suspending the contribution doesn’t reduce participant benefits already accrued by the amendment date, as accrued benefits are protected. For example, if the employer contribution is a 3% match and it is only allocated to participants if they make salary deferrals, future matching contributions can be suspended or reduced as they are not yet accrued and so not considered protected.

For information on these topics or the Coronoavirus Aid, Relief, and Economic Security (CARES) Act related to COVID-19, contact your Milliman consultant.

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