March 26, 2020 Article

COVID-19 and 401(k) Plans—Ability to Suspend Employer Contributions

As a result of the COVID-19 epidemic, many employers are looking to conserve cash in order to continue operations.  Some may wonder whether they can suspend employer contributions to 401(k) plans. Suspension of contributions has the immediate effect of reducing current employment costs for employers without having to take more drastic steps such layoffs or unpaid furlough. This post provides guidance on an employer’s ability to change contributions to 401(k) plans in the middle of a plan year. For simplicity, the discussion below assumes that the employer is the sponsor of the plan.

Please note that this is a general overview of changes to employer contributions. Specific provisions of a given 401(k) plan; including the 401(k) plan document (often called the basic plan, master, prototype document), the adoption agreement, and the summary plan description—may have an impact on an employer’s ability to suspend contributions. Employers should review all plan documents and consult with their benefits advisor or legal counsel before taking action to change contributions.

1. Employer Contributions: An Overview

Employer contributions to a 401(k) plan can take several forms, but they are generally either matching contributions or nonelective contributions (also referred to as “profit sharing”).

  • Matching contributions are amounts that an employer contributes on behalf of employees who make salary deferrals. The amount contributed by the employer is expressed as a percentage of the amount deferred by a participating employee.
  • Nonelective employer contributions are made without regard to employee deferrals. 

If an Employer has a firm commitment to make a specific amount of contributions, by Plan language or separate commitment, the contribution can be said to be “mandatory.” This could occur where the language commits the employer to a dollar amount, a specific percentage of pay or a match of employee deferrals over a stated period.  Otherwise, the contributions may be said to be discretionary; meaning the employer has the discretion, but not the obligation, to make contributions.

2. Mid-Year Suspension of Employer Contributions

An employer is generally able to suspend employer contributions to 401(k) plans unless the Plan mandates otherwise. This general rule is discussed further below. However, suspension of contributions under a 401(k) plan is more complicated if the plan has elected “safe harbor” status.

A. Safe Harbor 401(k) Plan

i. General.  Employers must conduct certain nondiscrimination tests (“ADP/ACP” tests) to ensure that 401(k) plans do not unfairly benefit highly-compensated employees at the expense of others. Treasury Regulations allow an employer to bypass the ADP/ACP testing requirements if its plan qualifies as a safe harbor plan and the employer elects safe harbor status.

Safe harbor 401(k) plans are subject to a minimum mandatory contribution level—which is either (a) a matching contribution equal to a 100% match on the first 1% of compensation deferred and a 50% match on deferrals between 1% and 6% of compensation deferred or (b) a nonelective contribution equal to 3% of compensation, regardless of employee deferrals. These minimum contributions may only be suspended if certain requirements (numbered below) are met. Even if permitted, suspension will cause a plan to lose its safe harbor status. Without safe harbor status, a plan will be subject to the ADP/ACP testing and related requirements for the entire year for which the amendment is effective.  Thus, before amending a safe harbor plan, an employer should ensure that the plan can meet its testing goals for the year.

Contributions can only be suspended prospectively and can only be effective after providing the eligible employees with 30 days’ notice and an opportunity to stop their own contributions. Thus, employer contributions will only be suspended once the 30-day notice period has lapsed.

ii. Restrictions on Suspending Contributions Mid-Year.  Suspension under a Safe-Harbor plan can only occur if all of the following conditions are met:

  1. Either (i) the annual safe harbor notice provided to the participants before the start of the plan year included a statement that the employer may suspend the contributions mid-year and that the suspension will not apply until at least 30 days after all eligible employees are provided notice of the suspension or (ii) the employer is operating at an economic loss for the plan year—determined pursuant to a facts and circumstances test provided for in IRC § 412(c)(2)(A) and the regulations related thereto;
  2. The employer provides all eligible employees (not just current participants) with a supplemental notice during the plan year that explains (a) the consequences of the suspension of contributions; (b) how participants may change their deferral elections; and (c) when the suspension takes effect;
  3. The suspension cannot become effective until the later of 30 days after the supplemental notice is provided and date the amendment is adopted;
  4. Eligible employees are given a reasonable period prior to the amendment taking effect to change their deferral elections—this is subject to a facts and circumstances test, but the time period is deemed to be satisfied if the notice is provided at least 30 (but not more than 90) days before the effective change and the plan allows for an employee to change deferral elections during that period;
  5. The plan is amended to provide that the ADP test will be satisfied for the entire plan year; and
  6. The plan satisfies the safe harbor requirements during the plan year up to the effective date of the amendment.

B. Non-Safe Harbor 401(k) Plan: Suspending Mandatory Contributions Mid-Year

If a plan’s mandatory employer contributions are not subject to the safe harbor restrictions, the mandatory employer contributions can be amended at any time to suspend the employer contributions on a prospective basis with respect to contributions that have not already been earned by the eligible employee.  The need for prior notice is dependent upon the terms of the plan documents. Even if the plan documents are silent on the subject, the employer should give 30 days’ notice and an opportunity for participating employees to change their salary deferral elections.

This is especially true if the plan is being amended to suspend matching contributions (rather than nonelective contributions). Many employees may have elected salary deferral contributions based on the expectation of a match.  Giving prior notice allows employees to change their deferral elections prior to losing the employer match.

A significant limitation on an employer’s ability to suspend contributions in a plan year is known as the “anti-cutback rule” (IRC § 411(d)(6)). The rule prohibits a plan from being amended in a manner that reduces or eliminates a benefit that the participant is already entitled to as of the applicable amendment date. For example, if an employee has already made a salary deferred contribution that is eligible under the pre-amendment plan to receive a match, such match is an accrued benefit to the employee and cannot be reduced. In addition, if an employee meets the eligibility requirements for a nonelective employer contribution set forth under the plan prior to the amendment, the amendment cannot reduce the amount the employee is already eligible to receive. The anti-cutback rule has significant complexities and its effects vary substantially based on the terms in the plan documents. An employer should seek the advice of counsel to determine whether the anti-cutback rule will be implicated by a proposed suspension.

Depending upon the terms of a plan’s documents, a complete suspension of the employer contributions for a prolonged period—i.e. 3 years—may cause a de facto termination of the plan, requiring 100% vesting of the employee’s right to accrued benefits regardless of the vesting provisions contained in the plan documents.[1]

C. Suspending Discretionary Contributions Mid-Year

If contributions are purely discretionary, and the employer has not communicated its commitment to make contributions, contributions can be avoided without amending the plan. However, employers should give prompt notice of this decision

3. Terminating 401(k) Plan

In lieu of suspending employer contributions, an employer can instead terminate a 401(k) plan. Employer ongoing contribution requirements and the ability of employees to make deferral contributions to the plan cease as of the termination date. On the effective date of termination, a participating employee becomes 100% vested in all the accrued benefits. After termination of the plan, the employer must distribute assets from the plan as soon as administratively feasible.

The employer is required to send two notices to the participating employees:

  1. Notice of Intent to Terminate: At least 60, but not more than 90, days before the proposed termination date, the employer is required to send all participating employees and/or beneficiaries a notice of the employer’s intent to terminate the plan.  
  2. Rollover Notice: At least 30, but not more than 180, days before the distribution of plan assets, the employer must notify participating employees and/or beneficiaries of their election rights with respect to distributions to be made from the terminated plan. The notice must include specific provisions based on the amount to be distributed to the participating employee. The plan documents may also require specific language be included in the notice. IRS Notices 2009-68 and 2009-75 provide sample notice language.

An employer should carefully consider the anticipated long-term operations of the company prior to deciding to terminate its 401(k) plan. The Code contains certain restrictions, known as the successor plan rule (see IRC § 401(k)(10)(A)), that essentially prohibit an employer from starting a new 401(k) plan within a year of the last distribution from the employer’s terminated 401(k) plan, subject to certain exceptions. The advantage to suspending the employer contributions—as compared to terminating the plan—is that the suspension of contributions is not permanent; employers can resume contributions at any point within a couple years of the suspension. With the long-term economic effects of the current pandemic not entirely clear, employers should consider suspending employer contributions as the first response and thereafter decide whether termination of the plan is appropriate. 

As discussed above, the procedure for changing an employer’s contributions under a 401(k) plan are largely dependent upon the terms of the plan, which include the 401(k) plan document itself, the adoption agreement, and the summary plan description. 

If you have specific questions regarding your 401(k) plan and options regarding the same, please do not hesitate to contact our taxation law group or employment law group.

 

[1] Although outside the scope of this blog post, if there is a complete discontinuance of contributions (excluding 401(k) plans’ employee deferral contributions) to a plan, the employer must treat the plan as a terminated plan. As a result of such deemed termination, the participating employees must be fully vested in their plan accounts. Whether there has been a complete discontinuance of contributions is a facts and circumstances test, but is generally found to have occurred if the employer has not contributed to the plan in 3 of the past 5 consecutive years. A deemed distribution could occur based on the employer freezing the plan for a prolonged period, or due to the continued suspension of employer contributions over a number of years.

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