Winter 2020/2021 Fiduciary Commentary
Beyond COVID-19’s destructive impact on society and public health, the pandemic has had a detrimental effect on many organizations’ financial position. As many companies struggle to cut costs and survive, some have chosen to eliminate employees and reduced expenses to weather the financial impact of the pandemic. Among the attractive targets for employers considering cost cutting is their funding to tax-qualified retirement plans.
During periods of financial duress, organizations often chose to temporarily suspend or reduce employer contributions rather than terminate the plan. A temporary suspension of plan contributions does not have the adverse effects of a plan termination such as the requirement to fully vest all employees and distribute participant account balances.
The organization’s ability to reduce or pause the funding of plan contributions is determined by the plan’s terms. Depending on the provisions of the document, changes to the employer’s funding obligations can be altered consistent with certain requirements.
Discretionary and Non-Discretionary Employer Contributions
Plan documents with provisions for discretionary employer contributions are not required to amend their plan to freeze contributions. Employers should simply adopt a resolution to memorialize its decision to pause plan contributions and ideally (but not necessary) notify the plan participants of the change in plan funding. Discretionary contributions can be restarted when business circumstances permit, without a plan amendment. Employers with a fixed or nonelective plan contribution have an additional step in the process. In addition to the corporate resolution to suspend or reduce contributions and notice to participants, an amendment changing the contribution formula would be needed.
If the plan maintains a safe harbor provision, the regulations to suspended contributions are a bit more cumbersome to undo. If the safe harbor notice identified that the employer maintained the right to reduce or suspend plan funding during the year, or if the employer was suffering an economic loss, the safe harbor contributions can be stopped with a plan amendment and an employee notice of the intended change and its effective date at least 30 days in advance of the change. Sponsors must also continue to make employer contributions up to the effective date of the amendment and non-discrimination testing must be performed for the entire year (defeating the purpose of the safe-harbor plan in the first place).
Employers also need to be aware of the partial plan termination rules as often involuntary terminations accompany sponsor financial stress. While a partial plan termination is based on the facts and circumstances, the IRS rule of thumb is if more than 20% of participants are terminated, the affected participants must be 100% vested.
Clearly, plan funding suspensions can be a convenient and relatively simple way to slash corporate expenses. To avoid the abuse of the rules permitting contribution suspensions without triggering a plan forfeiture, the IRS has established a rule that a sponsor cannot suspend contributions for more than three out of five years without the suspensions being treated as a permanent discontinuance of contributions.
The Pandemic and Plan Contributions
At the onset of pandemic, it initially appeared that the number of plan contribution suspensions would be significant. Early, after the onset of the pandemic, several large companies announced the suspension of their plan funding including Best Buy, Marriott, Kelly Services and Amtrack, among others. In fact, initial surveys from Willis Towers Watson and Plan Sponsor Council of America indicated that from 12%-20% of larger companies had suspended their employer contributions (with retail and business services having a higher rate of suspension). As a comparison, Willis Towers Watson data showed that almost 20% of companies with at least 1,000 employees had suspended or decreased their plan contributions during the Great Recession.
But today, almost a year after we began to hear the words Coronavirus, the latest data from the Center for Retirement Research suggests that approximately 1% of plan sponsors with more than 100 participants are currently operating their plan with a suspended plan match. The data suggests that organizations outside of travel and hospitality and those not as directly affected by the pandemic did not experience the same financial pressures, and did not need to suspend their plan contributions. Furthermore, some organization that had initially suspended plan funding out of fear for the uncertainty caused by the pandemic, have grown more comfortable enough to reinstate plan contributions.
Estimates are higher from those in the financial services industry that directly service qualified retirement plans. Numbers from T. Rowe Price show that approximately 9% of large plan sponsors suspended or reduced plan matching and Ascensus stated that 21% of their plan clients froze contributions. In contrast, among Vanguard’s plan clients, only 7% of companies had suspended their matches, and in November the Plan Sponsor Council of America (PSCA) found only 5% of firms reported suspending their match, noting that many companies who froze plan contributions have since reinstated them. In any case, based on the industry numbers, it seems reasonable to say that between 5% and 20% of plan sponsors have suspended their plan contributions.
Employer plan contributions to qualified retirement plans are a powerful tool for retaining existing employees and attracting new talent. The COVID-19 pandemic presents employers with many formidable challenges, among them the need to cut costs to remain competitive. Not only should plan sponsors strongly consider the workforce impact of the plan contribution suspensions, but also should make an informed decision based on the ERISA rules governing the decision relating to employee notices and other formal requirements.