The Coronavirus/Covid-19 pandemic will have a significant and negative impact on our industry. As a business owner, you might have to make unfortunate decisions as they pertain to staff—and yes, layoffs—so it will impact your 401(k) plan.
We’ve received plenty of guidance from local, state, and federal governments about how to proceed during this pandemic. Nothing from the Internal Revenue Service (IRS) or the Department of Labor (DOL) lets employers off the hook in their role as a plan sponsor and plan fiduciary.
While offices might be closed or shut down completely for the foreseeable future, you still have to operate a 401k plan as prudently as before the “world went awry.”
Termination vs. furlough
If the painful decision must be made to let some or all employees go, how it is done may affect the 401k plan, and whether these targeted employees can receive a distribution from their account balance.
Based on something contractual (such as collective bargaining) or the idea that the change to a business might be temporary, employees on furlough are treated differently than employees that are terminated for purposes of your 401(k) plan.
Employees that are furloughed are still considered employees—they haven’t been terminated. Without a severance of employment, these furloughed employees wouldn’t be entitled to an immediate distribution of their 401(k) plan.
While they may be entitled to a hardship distribution or a loan (depending on what the plan says), these furloughed employees can’t take their 401(k)-account balance to an IRA rollover, another employer’s retirement plan or in cash.
On the flip side, terminating these employees could negatively impact the 401(k) plan. If a large number of employees are terminated, the plan might go through a partial termination. A partial termination usually happens (based on facts and circumstances) if more than 20% of total plan participants were laid off in a particular year.
The partial termination rule requires all terminated employees to be fully vested in their account balance as of the date of the partial plan termination. They must become 100% vested in all employer contributions (including matching contributions) regardless of the plan’s vesting schedule.
So, when deciding what to do with employees, understand the difference between furlough and termination.
Severance and the impact on 401(k) plans
If the painful decision to terminate employees is made, keep in mind that severance pay is an issue for 401(k) plan compensation purposes.
If severance pay is included for purposes of compensation for 401(k) purposes, plan participants must be allowed the opportunity to defer from that severance pay.
According to the regulations, severance pay is to be included in compensation for a 401(k) plan if it meets all of the following criteria:
1) The payment is regular compensation for services performed during an employee’s regular working hours or compensation for services performed outside their regular working hours (such as overtime), a commission, bonus, or other similar payment,
2) the payment would have been paid to the employee before the severance from employment if the employee had continued working, and
3) the payment is made by the later of 2½ months after severance from employment, or the end of the limitation year that includes the date of severance from employment.
Plan participants need to get those notices
Thanks to social distancing and working from home, disseminating required notices to a 401(k) plan is more difficult. Also, employees may want a summary plan description or other information in light of the pandemic.
Under ERISA, SPDs and other plan documents must be provided to employees within 30 days following the employee’s request. If employees are working remotely or have been terminated/furloughed, SPDs can also be distributed through the mail or electronically.
If distributed electronically, SPDs and other plan documents should be provided in compliance with the electronic disclosure rules.
Just remember that even though employees may not be working at the office, they’re still entitled to their ERISA protected notices. Whether emailed or physically mailed, the plan sponsor still has a responsibility to provide this information.
Should employer contributions be eliminated?
If the 401(k) plan has required-contributions, such as a safe harbor 401(k) or a stated matching contribution, or another retirement plan with minimum funding requirements (defined benefit/cash balance/target benefit/money purchase), or even if a discretionary employer contribution (such as matching and profit-sharing contributions), now is the time to consider whether these contributions are now affordable.
Thanks to accrual requirements with many mandatory contributions, realizing it can’t be afforded in December isn’t going to help you avoid that mandated contribution.
As a plan sponsor, a lot more leeway is possible in perhaps freezing or eliminating these types of contributions if the affordability issue is realized before June 1.
If a discretionary contribution is offered, such as matching or profit sharing, it’s probably a better idea to decide now whether the contributions should be suspended. Participants can then plan accordingly, especially for matching contributions if the plan documents call for matching contributions to be made every payroll period. If a lack of revenue as a result of this pandemic necessitates saving, consider ASAP whether suspending and/or eliminating any type of employer contributions in needed.
Terminating the plan is a bad idea
Being a 401(k)-plan fiduciary isn’t easy, but the last thing to do is panic and do something rash. Consider terminating the 401(k) plan, but it’s to be avoided should the business continue to operate. The reason is the successor plan rule. The rule prohibits an employer from terminating a 401(k) plan, distributing the plan assets to participants, and, then, starting a new plan within 12 months after the original plan is terminated (with very limited exceptions).
So, terminating the plan, in this case, is a terrible idea, because it will likely preclude the offering of another plan for a year.
Ary Rosenbaum is an author and ERISA/retirement plan attorney for his firm, The Rosenbaum Law Firm P.C.
He is also the host of That 401k Conference, a series of fun and informative retirement plan conferences taking place in various cities throughout the year.
Rosenbaum’s latest book, humbly titled “The Greatest 401k Book Sequel Ever,” is available in Kindle and paperback at Amazon.com.
Ary Rosenbaum is an author and ERISA/retirement plan attorney for his firm, The Rosenbaum Law Firm P.C.
