In the wake of the coronavirus outbreak, one of the many issues plan sponsors face is determining whether employees will be furloughed and for how long.
What is a furlough?
A furlough is defined as an employer-implemented mandatory leave of absence from work, typically without pay—very similar to a temporary layoff or approved unpaid leave of absence. The idea is that workers will one day be able to return to their work.
What effect does an unpaid leave or furlough have on retirement 401(k) plans?
While furloughed employees still technically retain their jobs, they cease actively working for their employers and may or may not earn salaries. An employee on an unpaid furlough clearly would not be able to make new salary deferrals. Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, an employee on an unpaid furlough is permitted a delay of up to one year for making loan repayments with due dates that fall between March 27, 2020, and December 31, 2020. Employer matching contribution obligations to a defined contribution (DC) retirement plan such as the 401(K) generally will cease once employee salary deferrals are discontinued, but employer “profit sharing” or nonelective contributions still may be due, depending upon the terms of the plan.
Employers will need to be vigilant when monitoring outstanding participant loans to ensure that any delinquencies are addressed promptly. In addition, the expanded availability of participant loans and hardship distributions under the CARES Act likely will create additional administrative work for employers where furloughed employees are involved.
Furloughed employees will not accrue hours of service if they are not working or receiving salaries. If no hours of service accrue, it may impact vesting as well as eligibility requirements for plan participation or contribution allocations. Upon returning to work from an unpaid leave or furlough, an otherwise eligible employee generally would be entitled to immediate reenrollment in a retirement plan.
Although a furlough is not a severance from employment, the Internal Revenue Service (IRS) could take the position that employees furloughed on a long-term basis, because of COVID-19, could be considered to have a severance from employment.
How does a furloughed employee, impacted by COVID-19, access retirement plan accounts?
The CARES Act has provided some relief for furloughed employees affected by COVID-19. Please refer to this Milliman benefits update to read more about coronavirus-related distributions (CRDs) and relaxed loan rules.
What about hardship withdrawal options because of this national emergency? Many plan documents state that hardships are allowed for the IRS safe harbor reasons. While the IRS safe harbor permits hardship withdrawals related to a Federal Emergency Management Agency (FEMA)-declared disaster, the state or area of primary residence would not only need to be declared a disaster area, but also must qualify for individual assistance. Without this specific situation applying, to permit these distributions, plan sponsors have to be comfortable deviating from the IRS safe harbor list of permissible hardship events.
If a plan sponsor would like to add a non-safe harbor hardship withdrawal in connection with COVID-19 and/or furloughs and layoffs, then a plan amendment is likely required.