Employee Benefit Options in a Time of Crisis

As the challenges related to COVID-19 continue to sweep across the globe, and companies begin to experience cash flow issues, we have received numerous questions related to 401(k) plans and what opportunities there are to reduce an employer’s cash obligation while also allowing greater access to retirement funds by employees. Provided below is guidance for an employer to consider in response to those questions.

I. Employer Contributions

An employer may consider a reduction or elimination of employer contributions to its 401(k) plan as one method of addressing cash flow issues. Below we discuss discretionary employer contributions and safe harbor contributions.

A. Discretionary Employer Contributions

If a 401(k) plan provides for discretionary employer contributions, amending the plan document to reduce or eliminate the contribution will reduce or eliminate an employer’s obligation. Depending on the plan’s terms, it may also be possible for an employer to reduce/eliminate the amount of discretionary employer contributions by resolution of its governing board. An employer should consult with its ERISA counsel to ensure that it properly adopts the change. In addition, the employer must provide notice to its participants of the change. A company should work with its third-party administrator or ERISA counsel to make the notification.

B. Safe Harbor Contributions

If a 401(k) plan provides for safe harbor contributions, the elimination or reduction of the safe harbor contribution requires a different and more complex analysis. Generally, a 401(k) plan that elects safe harbor status may not retroactively change the safe harbor contribution amount (or eliminate the feature altogether) during the Plan Year, unless one of two things is true. First, a plan may change its safe harbor contribution feature if the notice to participants which disclosed the plan’s safe harbor status reserved the right of the employer to change this election. If the reservation was not present in the participant notice, then an employer is required to make the contribution unless it is operating at an “economic loss.” If the employer is operating at an “economic loss” or has reserved its right to change the safe harbor status, it may take the following steps to complete this change.

• Consult with its third-party administrator and ERISA counsel to amend the plan document in accordance with the applicable regulations.
• Notify participants of the change and allow participants to make changes to their deferral contributions. Note that the amendment may not become effective until 30 days after participants are notified of the change.
• Plan ahead for discrimination testing later in 2020. Without a safe harbor election, a 401(k) plan will be required to conduct and pass ADP and ACP discrimination testing.

II. Participant Access to Funds

A. Participant Loans

One way to allow access to retirement assets by an employee is to permit participant loans from the 401(k) plan. If an employer’s 401(k) plan does not currently permit loans, the plan will require an amendment that outlines the process and procedure to allow for the loans. Generally, a participant is permitted to take a loan from his or her 401(k), but only up to 50% of the participant’s vested plan benefit not to exceed $50,000. Participant loans are generally paid back to the plan through payroll deduction over a five-year period of time (the “Payback Period”). If the loan is defaulted or is not repaid, the remaining balance on the loan becomes taxable income to the participant. If a participant is terminated from the employer during the Payback Period, the remaining balance generally must be immediately repaid.

The Coronavirus Aid, Relief and Economic Security (“CARES”) Act provides expanded loan provisions for certain participants who are financially affected by COVID-19 (“Eligible Participants”). The maximum amount of a plan loan taken by Eligible Participants can be increased to the lesser of $100,000 or 100% of the participant’s vested account in the plan. This change can be made effective for the first 180 days after enactment of the CARES Act (March 27, 2020).

Additionally, a plan sponsor may allow Eligible Participants who have existing plan loans to suspend their loan payments for up to one year. The payments that can be delayed are those with due dates between March 27, 2020 and December 31, 2020. Subsequent loan payments would need to be adjusted to reflect the delay and any interest that accrues during the delay.

A plan participant is an Eligible Participant and able to take advantage of these new rules if the participant meets one of the following requirements:

• the participant has been diagnosed with COVID-19;
• the participant has a spouse or dependent who has been diagnosed with COVID-19; or
• the participant has experienced adverse financial consequences stemming from COVID-19 as a result of:
  • being quarantined, furloughed or laid off;
  • having reduced work hours;
  • being unable to work due to lack of child care;
  • the closing or reduction of hours of a business owned or operated by the participant; or
  • other factors determined by the Treasury Department.

B. Participant Withdrawals

An additional way that a 401(k) plan can provide access to 401(k) plan funds is through in-service distributions. In-service distributions occur when an employee takes money from his or her 401(k) but remains employed by the employer. Plans may permit in-service distributions and/or hardship withdrawals, subject to several rules.

1. In-Service Distributions

The general rule is that in-service distributions may be permitted for participants who have reached age 59½ or older (as provided in the plan). However, the CARES Act expands the in-service distribution rules by allowing plan sponsors to permit an Eligible Participant who has been financially affected by COVID-19 (based on the criteria listed in Section II.A. above) to take an in-service distribution of up to $100,000 at any age. Such a distribution is not subject to the 10% additional tax on early distributions and 20% withholding that would otherwise apply. Additionally, such distributions can be re-contributed to the plan during the three-year period following the distribution and be treated as non-taxable transfers. The income tax on any contributions that are not re-contributed to the plan within the three-year period would be spread ratably over three years. This type of distribution can only be made during the 2020 calendar year. The 401(k) plan document must contain provisions concerning in-service distributions before such distributions may be administered. An employer should consult with its ERISA counsel to confirm or add such provisions to its plan.

2. Hardship Withdrawals

Hardship withdrawals may be permitted from a 401(k) plan for participants who experience an “immediate and heavy financial need.” The Internal Revenue Service has provided a series of circumstances that are considered immediate and heavy financial need. Those include:

• medical expenses incurred or necessary which are not covered by insurance for a participant, the participant’s spouse, the participant’s dependents and the participant’s primary beneficiary under the 401(k) Plan;
• purchase (excluding mortgage payments) of a participant’s principal residence;
• payment of tuition for the next 12 months of post-secondary education for a participant, a participant’s dependents or a participant’s primary beneficiary under the 401(k) Plan;
• the need to prevent eviction from or foreclosure on the mortgage of a participant’s principal residence;
• payment of burial or funeral expenses for a participant’s deceased parent, spouse, children, other dependents, or primary beneficiary;
• expenses for the repair of damage to a participant’s principal residence that would qualify for the casualty deduction under the Internal Revenue Code; and
• expenses and losses for certain federally declared disasters.

The need to pay medical expenses, prevent eviction from foreclosure, and the payment of burial or funeral expenses may all be applicable as a result of COVID-19. To receive a hardship withdrawal, participants may be required to provide specific paperwork to demonstrate their immediate financial need and the withdrawal must be limited to the amount required to pay for the hardship.

While hardship withdrawals do not need to be repaid to the plan, they are subject to taxation upon distribution and Participants younger than age 59½ will incur a 10% early withdrawal penalty. An employer should consult with its ERISA counsel to confirm or add this feature to its plan.

III. Participant Contributions

As a result of reduced hours or a change in personal finances, employees may want to reduce the amount of the deferrals that they are making to the 401(k) plan. If the plan only permits an employee to make a change to his or her deferral elections quarterly or monthly, an employer may consider amending the plan to permit changes on a payroll-by-payroll basis. The plan’s ERISA counsel can assist with such an amendment, and its third-party administrator can assist in ensuring that all participant elections are accurate and are made in an efficient manner.

IV. Required Minimum Distributions

Generally, 401(k) plan distributions may not be delayed longer than permitted under the required minimum distribution rules (e.g., the participant's attainment of age 70^1/2) However, the CARES Act provides a waiver of any required minimum distributions that otherwise would have been due in 2020. This provision facilitates 401(k) plan administration this year.

V. Deadline for CARES Act Amendments

If a plan sponsor wants to implement any of the changes permitted under the CARES Act, it must amend its plan and provide notice to participants. Nongovernmental plan sponsors have until the end of the plan year beginning on or after January 1, 2022 to adopt such amendments. With regard to amendments that do not relate to CARES Act changes, an amendment must be adopted before the change that it implements. As always, we recommend providing notice to participants of any implemented changes as soon as possible.

Please contact ERISA attorneys Mindi Johnson, Julie Hamlet, or Amanda Dernovshek about your 401(k) plan and how you can use it to ease the financial distress during the COVID-19 pandemic.

Mindi Johnson...616.726.2252...mjohnson@fosterswift.com
Julie Hamlet...616.796.2515...jhamlet@fosterswift.com
Amanda Dernovshek...517.371.8259...adernovshek@fosterswift.com