Because of the international health crisis caused by the coronavirus (COVID-19), retirement plan sponsors, and the compensation professionals and retirement plan administrators that advise plan sponsors, are in unchartered territory contemplating potentially long-term changes in the workforce and the financial stability of the plan sponsors and plan participants. Current retirement plan designs and traditional plan administration and governance rules, as well as potential new legislation under consideration or being recommended to Congress, may present plan sponsors with some choices to make in terms of cost savings measures for companies and access to funds for employees. This Holland & Knight alert describes some of the choices that are available as the consequences of the health crisis become clearer.
Please note, this alert is a general outline of the issues and not an analysis of any particular retirement plan. As such, the following should not be relied upon as legal advice regarding how any specific company or individual would respond in a specific situation. In addition, the challenges are changing rapidly and new legislative changes or suspensions may apply soon.
Considerations for Cost Savings in Your Retirement Plans
- Suspending Employer Contributions in 401(k) Plans. Companies may want to consider immediate suspension of employer contributions to 401(k) plans. Most employers, including those with safe harbor plans, have options to suspend contributions under certain circumstances. Notices to employees may apply, delaying the effective date of the suspension, and this strategy would need to be analyzed on a plan-by-plan basis.
- Terminating 401(k) Plans. Depending on the severity of an employer's economic situation, an employer could consider completely terminating a plan, which would cease employer contribution, ultimately reduce administration costs and require full vesting of participant accounts. This requires careful planning and coordination with vendors to distribute assets. In addition, terminating a plan would generally prohibit the employer from adopting a new 401(k) plan for 12 months after distributing all of the assets of the terminated plan. In the case of a business closing its doors, winding up the plan and making distributions to the participants would be required.
- Freezing Pension Plan Accruals. Freezing defined benefit pension plan accruals is consistent with many employers' long-term plans as they move to 401(k) plans. Notices are required several weeks prior to freezing benefits and may require union negotiations. Planning ahead is crucial to properly freeze accruals under a defined benefit plan.
- Terminating a Pension Plan. Much like freezing pension plan accruals, terminating a pension plan requires planning ahead, notice to participants and coordination with the Pension Benefit Guaranty Corporation (PBGC). Terminating a pension plan has more significant repercussions on companies, including meeting funding obligations, and may not be a viable option at this time given the current economic situation and cost of adequately funding a plan for termination purposes.
Considerations for Employee Access to Retirement Plan Funds
- Stopping Employee Contributions. Employees always have the option to stop payroll contributions to a 401(k) plan to manage immediate access to funds. Now may be a good time to remind employees how to change contributions, in case they need additional cash flow in the coming weeks.
- Loans from 401(k) Plan. Many employers provide for plan loans in their 401(k) plans, which will not be treated as a taxable distribution if repaid in accordance with legal requirements. At this time, reminding employees of access to loans and even increasing access to loans for employees could be a real help for those in need of cash. Whether an amendment is required to the plan would need to be determined on a plan-by-plan basis. Employers planning to decrease access to loans, or those that have decreased in the past, may want to reconsider loan access and make access to funds easier, at least for a period of time. Similarly, employers with plans that do not currently provide for plan loans may want to consider amending the 401(k) plan to allow for plan loans. However, the terms and repayment of plan loans must satisfy certain requirements to avoid treating the loan as a taxable distribution to the participant, which could also include an additional 10 percent early distribution tax.
- Hardship Withdrawals. Much like loans, employers often provide hardship withdrawals in their 401(k) plans. This is another way for an employee to access cash from their retirement plan, and can be accessed for a variety of reasons. Unlike plan loans, hardship distributions do not need to be repaid, but they are treated as a taxable distribution. Conditions such as decreased hours, loss of a spouse's job, increased child care or healthcare costs could trigger significant additional needs that could allow for an employee to access those funds as a hardship. Special rules apply if the employee's home or workplace is located in an area that is declared to be a major disaster by the Federal Emergency Management Agency (FEMA). At this time, the Internal Revenue Service (IRS) hasn't changed the safe harbor hardship withdrawal rules, so employees have to meet those requirements as written under the plan. Holland & Knight will continue to monitor the situation for new legislative or regulatory developments.
- Termination of Employment.
- Employees whose employment terminates generally are allowed to receive distributions. Termination of a significant number of employees (a rule of thumb is 20 percent or more of the employee population) during a year because of the occurrence of an event affecting the employer could result in a partial plan termination, which would require full vesting for those affected by the partial termination. It is advisable to carefully monitor terminations and take action on vesting as soon as possible, rather than having to locate participants for additional distributions of those newly vested amounts upon realizing that a partial termination has occurred.
- In many cases, a plan loan must be repaid upon termination of employment (or within a short period following termination) or the loan is deemed to be in default. Revising the loan provisions of a plan to allow for loans and loan repayments for a short period of time after termination is an option that could be considered and appropriate for some employers to help employees avoid additional tax. Many companies made these changes after a change in the law in 2018.
- Employees on Unpaid Leave or Furloughed Employees. Employees with plan loans who are not currently receiving a paycheck, such as those on an unpaid leave or furlough, can repay loans under certain circumstances, depending on the plan terms. Loan payments can be paid with a combination of balloon payments or increasing installments, but will need to be paid within the original term of the loan. If plan terms or loan policies do not currently permit loan payment other than through payroll withholding, in the current environment employers may want to adjust procedures to accept direct pay.
Upcoming Legal Changes to Retirement Plans
It is almost a certainty that the current law governing retirement plans will change. Implementation of those changes quickly could assist companies and employees. Holland & Knight is monitoring provisions being considered by the U.S. Senate and the requests for changes by various benefits organizations.
New proposed legislation currently in the U.S. Senate under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, as of March 24, 2020, includes changes to retirement plans to assist those affected by COVID-19. The focus is on allowing additional flexibility within retirement plans for participants who are economically affected by the virus. A short outline of those proposed provisions follows.
- Tax-favored distributions from retirement plans that are "coronavirus-related distributions," which is defined as any distribution from an eligible retirement plan or IRA made on or after Jan. 1, 2020, and before Dec. 31, 2020, to a participant who has been affected.
- Those affected include participants diagnosed with the virus, his or her spouse or dependents, those participants being quarantined, furloughed, laid off or experiencing reduced hours, participants that need child care, and for those affected by a business closing or reduced hours of a business owned or operated by the individual.
- Distributions of up to $100,000 to affected participants can be treated as a tax-free rollover as long as it is repaid to an eligible plan within three years. Even if not repaid, such distributions will not be subject to the 10 percent early distribution tax.
- Allowing loans up to the lessor of $100,000 or 100 percent of the participant's vested account balance (the current limit is the lesser of $50,000 or 50 percent of the vested account balance). Loan repayments can be delayed for up to one year.
- Relief for student loan repayment (allowing more funds for current issues or saving for retirement).
- Waiver of required minimum distributions for calendar year 2020 for 403(b) plans and individual retirement accounts (IRAs).
Industry organizations have also submitted proposals to U.S. legislators that include, in addition to variations of the relief now being considered:
- waiver of required minimum distributions for calendar year 2020 for all defined contribution plans and IRAs
- waiver of penalties for distributions, hardships and deemed distributions from loan defaults
- extending IRS filing deadlines for pension plans and contribution deadlines for IRAs, and
- relief for defined benefit plans, including in the form of extended notice and reporting deadlines, guidance on the application of spousal consent rules, delayed funding deadlines and revised amortization and interest rate requirements and other requirements for assessing the amount of required funding and capped or relieved PBGC premium payments
In the upcoming days, a clearer picture is expected to emerge of whether the CARES Act will become law either in current form or will be modified at the request of industry organizations. It is also likely that even if not included in this round of legislation, Congress and the IRS will continue to evaluate ways in which to mitigate the economic effects of the COVID-19 outbreak, which could include additional changes to increase flexibility, ease economic hardship and help Americans get back on the necessary path for retirement.
If you have any questions regarding your retirement plans and the potential impact of the new legislation on them, please contact the authors or another member of Holland & Knight's Employee Benefits and Executive Compensation Group, including Partners Bob Friedman, Ari Alvarez, Kelly Bley, Gregory Brown, Christopher Buch, Kerry Halpern, John Martini, David Pardys and Rachel Shim.
DISCLAIMER: Please note that the situation surrounding COVID-19 is evolving and that the subject matter discussed in these publications may change on a daily basis. Please contact the author or your responsible Holland & Knight lawyer for timely advice.
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem. Moreover, the laws of each jurisdiction are different and are constantly changing. If you have specific questions regarding a particular fact situation, we urge you to consult competent legal counsel.