Top 5 questions employers are asking about their 401(k) plans

Mark Cover

By Mark Cover
Mark Cover is the Head of DCIO Field Sales for MassMutual Investments.
Posted on May 15, 2020

We’ve seen disruptions in the markets before, but what we are experiencing now feels different. The COVID-19 crisis has pervading humanistic and economic aspects that seem to shake us at our very core as many businesses are dealing with the financial implications of social distancing. We will get through this, but it will not be easy.

What are plan sponsors most concerned about?

Two words: Cash flow.

This is first and foremost in the minds of many business owners right now. Payroll and employee benefits, being one of business’s highest expenditures, become the first targets for many cutbacks. Employers with defined contribution plans, that we call plan sponsors, are asking what cost-saving measures, if any, they can take now with their retirement plans.

Through a program called PlanChampionSM we work closely with the Retirement Learning Center (RLC), a well-recognized ERISA consulting firm that assists financial professionals that work with companies that offer retirement plans, like 401(k)s. For some insight, we asked RLC to see if what we were hearing matched up with calls they were getting. Here are the top questions from sponsors we heard:

  1. Can a standard 401(k) plan be amended to remove employer contributions and, if so, how?
  2. Can a 401(k) safe harbor plan be amended to suspend or eliminate the safe harbor contribution?
  3. When does a partial plan termination happen and what are the ramifications?
  4. Can a plan sponsor change the plan’s matching contribution funding frequency from per payroll to year end?
  5. Are hardship distributions as a result of Covid-19 exempt from the 10 percent early distribution penalty tax?

Some of the answers to these questions have important considerations that plans sponsors need to make with their retirement plans. So we put together some information to help that include some new points based on the passing of the CARES Act.

Q&A: Top 5 plan sponsor concerns

1. Can a standard 401(k) plan be amended to remove employer contributions and, if so, how?

Yes, it can, and the precise steps depend upon whether the employer contributions are discretionary or mandatory (i.e., fixed).

Standard 401(k) discretionary nonelective or matching contributions may be reduced or eliminated at any time since they are discretionary. Although not required, communicating the change to plan participants would be beneficial — especially if they have been accustomed to receiving these contributions in the past. Typically, no plan amendment is required. Nondiscrimination testing should be considered (i.e., to ensure the change in the formula does not unduly favor high compensated employees).

Standard 401(k) mandatory employer contributions may be eliminated mid-year on a prospective basis by amending the plan document. The employer must make the contribution for the portion of the year prior to the amendment for those who satisfy the eligibility requirements to receive it. Nondiscrimination testing should be considered. Participants must receive a Summary of Material Modifications or an updated Summary Plan Description that describes the change.

2. Can a 401(k) safe harbor plan be amended to suspend or eliminate the safe harbor contribution?

Yes, but only because of economic loss, or if the annual notice before the start of the plan year indicates the employer may reduce or suspend contributions mid-year. These are limited circumstances, and according to final Treasury Regulations, a sponsor of a 401(k) safe harbor plan may amend the plan during the current year to reduce or suspend the company’s safe harbor contribution—either the matching or non-elective contribution.1 However, the plan becomes subject to the actual deferral percentage and/or actual contribution percentage test.

An “economic loss” for the year is referenced in the Internal Revenue Code Section [IRC 412(c)(2).2

While the IRS has not expanded on the definition of economic loss for this purpose, under generally accepted accounting principles, documentation by the employer that the business’s expenses exceeded income for the year would, presumably, may suffice.

3. When does a partial plan termination happen and what are the ramifications?

When a significant number or percentage of employees who are participating in a business’s qualified plan are terminated and/or are no longer eligible to participate in the plan, a “partial termination” may have occurred in the eyes of the IRS. The determination is based on the facts and circumstances of each case.

The IRS requires that all participants covered under the portion of the plan deemed terminated become 100 percent vested in matching and other employer contributions if the contributions were subject to a vesting schedule under IRC §411(d)(3) 2 and Treasury Regulation 1.411(d)-2 .3

The IRS presumes there is a partial termination when an employer reduces its workforce (and plan participation) by at least 20 percent. This presumption is rebuttable, however. For example, if the situation is such that the turnover rate is routine for the employer, that favors a finding that there is no partial termination (see Revenue Ruling 2007-43).5 Whether a partial termination has happened may not be an easy call. The IRS makes it clear that the determination of a partial plan termination is based on the facts and circumstances of the particular scenario ( Treasury Regulation § 1.411(d)-2(b)).

Certain vesting requirements may need to be met in regards to employer contributions. If those are not met and later corrected in the Employee Plans Compliance Resolution System (EPCRS), the IRS could potentially disqualify the plan. Keep in mind, a partial termination is not a onetime event, but judged over a plan year, or potentially longer. If an employer has a series of layoffs during a plan year, in totality, the layoffs might add up to 20 percent, and give cause for concern.

4. Can a plan sponsor change the plan’s matching contribution funding frequency from per payroll to year end?

Yes, sponsors of both standard and safe-harbor 401(k) plans can adjust the funding frequency mid-year.

For a standard 401(k) plan, a sponsor should confirm if an amendment is needed to the plan document. Some plans allow funding flexibility and would not require an amendment. Other documents have specific language that addresses the funding timing that may need to be amended.

For a safe harbor 401(k) plan, a sponsor can change from per-pay-period funding to year-end funding with a retroactive plan amendment and notice to employees no later than three months before the end of the year (see IRS Notice 2016-16).4

5. Are hardship distributions as a result of Covid-19 exempt from the 10 percent early distribution penalty tax?

Yes, under the newly enacted Coronavirus Aid, Relief, and Economic Security (CARES) Act), the IRS will waive the 10 percent early distribution penalty for the first $100,000 of a “Coronavirus-Related Distribution” from an eligible retirement plan due to Coronavirus. Distribution recipients may pay back the amount within three years; and taxation can be spread over three years. The term ‘‘eligible retirement plan’’ includes individual retirement accounts and annuities (IRAs), qualified pension, profit-sharing, or stock bonus plans (including 401(k) plans), qualified 403(a) annuity plans, 403(b) annuity contracts and custodial accounts, and governmental section 457 deferred compensation plans.

A Coronavirus-Related Distribution is an amount taken by an eligible person between January 1, 2020, and before December 31, 2020; and, despite being eligible for rollover, is not subject to the mandatory 20 percent federal withholding amount.

It is important to understand and comply with the criteria of who the IRS has determined “eligible” as defined by the CARES Act. The IRS may add additional criteria to their list as time progresses, but a plan administrator may rely on a participant’s certification that the participant satisfies the requirements to be an eligible person.

Plans Sponsors are not required to offer Coronavirus-Related Distributions, but it is good to note any plan amendments required as a result of the CARES Act will be due as of the last day of the plan year beginning on or after January 1, 2022 (2024 for a governmental plan) or possibly later at the IRS’s discretion. For example, plan amendments for a nongovernmental, calendar year plan would be due by December 31, 2022.

Conclusion

These are unprecedented, but not insurmountable, times for businesses and their retirement plans. Addressing the crisis can become more manageable when business owners and their financial professionals adopt a phased approach. We view this as “Phase I” to assist in shoring up the business and managing cash flow as a business’s retirement plan is a logical consideration for immediate cost savings. However, we believe a business’s long-range financial stability is dependent on a consistent and content workforce. Retirement plans help facilitate employee financial wellness and, therefore, we suggest that it should be an integral part of a business’s long-range financial plan.

Please view our full whitepaper  to learn more about these topics in more detail with additional action steps that can be taken.

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John Carl, the Founder and President of Retirement Learning Center, contributed to this article.

 

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The material presented in this text has been drawn from sources believed to be reliable. Every effort has been made to ensure the accuracy of the material. However, the accuracy of this information is not guaranteed. The laws and regulations governing IRAs and retirement plans change frequently, and sometimes with limited or no advance notice. The information provided here is for general informational purposes only, and should not be considered as personalized investment advice. 
The Retirement Learning Center is not affiliated with MassMutual or any of its subsidiaries.
The information provided is not intended as specific tax or legal advice. None of the firms represented are authorized to give tax or legal advice. Tax or legal advice should come from tax or legal counsel.
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