COVID-19: Retirement Plan FAQs

March 26, 2020
Firm Publication

This set of FAQs is part of a series dealing with the impact of COVID-19 on businesses. Government-mandated protocols and social distancing directives as a result of the COVID-19 pandemic have led to significant business interruptions and tremendous financial strain on employers. These measures may continue to disrupt businesses and the economy for the foreseeable future. As a result, employers are faced with difficult choices regarding their employees–including how to keep them working during this unprecedented time and for many employers, possibly reducing employees’ hours, furloughing employees, or terminations–all of which can directly affect retirement plans and other types of employee benefit plans.  In addition, a wave of new federal legislation affecting employee benefit plans, much of which is intended to provide relief to employees, is being rolled out. This set of Q&As addresses some of the most common retirement plan questions that arise as employers make business and staffing decisions in response to COVID-19. Other Q&As addressing workforce reduction options, what to do when an employee is diagnosed with COVID-19, health coverage and other welfare benefit plan issues, and deferred compensation arrangements in light of COVID-19 are available here.  We will continue to update these and other topics as continued legislation and guidance are issued. Bass, Berry & Sims also offers a COVID-19 resource center that offers more guidance.

General Items

Many employers are considering placing a group or groups of employees on furlough.  What does this mean?

“Furlough” can mean different things for different employers.  This term is often used for a period during which federal employees are not working, after which they are frequently given back pay.  In the case of the current COVID-19 pandemic and for private employers, however, this term is being used to describe an employer-mandated leave of absence without pay.  This is the definition that we rely upon in these Q&As and others in our series.  Contrast a furlough with a “termination,” which is a cessation of the employment relationship and can be temporary or permanent.

Should we continue to hold committee meetings and communicate with our plan’s investment advisors?

Yes, continuing to have virtual committee meetings and engaging in regular communications with your plan’s investment advisors is critical at this time, especially as the financial and legal landscape in the U.S. is changing in response to COVID-19.  Emergency federal legislation will likely result in plan changes and other plan modifications.  You should also ensure that you continue to follow the provisions of your investment committee charter.

401(k) and Profit-sharing Plans

We’re considering reducing or suspending employer contributions. Can we do this?

It depends on how your plan is structured. If your plan does not utilize a safe-harbor design—a design that requires employers to make certain levels of employer contributions to avoid nondiscrimination testing—then you likely have the ability to reduce or even eliminate your employer contributions prospectively.

If your plan utilizes a safe-harbor design, then you may reduce or suspend your employer contributions in two instances: first, if your annual safe-harbor notice stated that employer contributions could be reduced or suspended during the plan year; or second, even if your notice did not contain this language if your company is operating at an economic loss for the plan year.

If you do reduce or suspend the employer safe-harbor contributions, then you must give employees at least a 30 day notice before taking action (i.e., before the plan amendment becomes effective). Additionally, if you stop making safe-harbor employer contributions, your plan will need to pass certain nondiscrimination tests for the plan year.

We’re considering putting employees on furlough. How will this affect employees vesting in our retirement plan?

If your retirement plan counts employees’ actual hours of service to determine vesting, then a furlough will interfere with an employee’s vesting if the employee works less than 1,000 hours during the year of furlough. However, if your retirement plan determines vesting using the elapsed time method, then the furlough should not negatively affect vesting service. This is because, in general under the elapsed time method, an employee’s vesting service is counted from his or her first day of employment and continues to run until the employee is terminated.

If we terminate or place a large group of employees on furlough, does this affect vesting differently?

It can.  If you terminate 20% or more of your workforce during the plan year, then the IRS views your plan as having experienced a partial plan termination, which requires 100% vesting for all employees terminated during that year.  The IRS reviews the facts and circumstances surrounding layoffs to determine if a partial termination has occurred.

Furloughs are a trickier issue. The IRS generally defers to employer determinations of employee status, so furloughed employees may not count toward that 20% threshold because the employment relationship has not been terminated. However, the longer a furlough lasts the more it looks like a termination. Employers should consider the length, and potential impact on employee vesting service, that furloughs may have when determining whether a partial termination has occurred.

Can our employees receive plan loans from their 401(k) accounts during a furlough?

If your plan allows for plan loans this option may be available to employees on furlough, depending upon the circumstances.  You will need to review your plan’s loan policy to ensure that employees on furlough or leave of absence are still permitted to take loans.  If needed, your plan’s loan policy could be changed to accommodate this.  You will also need to work with your plan’s third party administrator to ensure that furloughed employees have a mechanism to make loan repayments at a time when they are not receiving wages.

As a reminder, plan loans are currently limited to the lesser of 50% of a participant’s account balance or $50,000.  However, note that Congress is expected to increase the maximum loan amount in the case of participants affected by the COVID-19 pandemic as part of a legislation package named the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which is expected to pass very soon.  We will provide an update as soon as one is available.

In the alternative, plans are permitted to temporarily suspend loan repayments while participants are on bona fide leaves of absence without pay, up to one year. In this case, the loan terms are not extended by the grace period. Your plan’s loan policy should be reviewed to see if this option is available or revised to include this option.

Can loan repayments for new or existing plan loans be suspended during the COVID-19 pandemic to help our participants?

It depends.  Plans are permitted to temporarily suspend loan repayments while participants are on bona fide leaves of absence without pay, up to one year.  Employees on furlough should meet this requirement, but other employees may not depending upon their work status.  If a suspension occurs, the participant must resume loan payments after the end of the suspension, the amount of the installments must not be less than the original installment amounts, and the loan must still be fully paid by the end of its original term.  IRS rules also permit plans to have a grace period if a loan payment is missed, where the missed payment must be made no later than the end of the quarter following the quarter in which the missed payment occurred.  Your plan’s loan policy should be reviewed to see if these options are available or revised to include these options if desired.

Can our employees take hardship withdrawals as a result of the COVID-19 pandemic?

Most employers utilize the IRS’s list of safe-harbor events to determine whether participants can take hardship distributions.  One of these events occurs when expenses or losses (including loss of income) are incurred on account of a federal disaster, provided the employee lives or works in the area designated by FEMA for individual assistance. Currently, COVID-19 has been officially declared an “emergency,” but not yet a “disaster,” so it does not yet meet one of the IRS’s safe- harbor events.  However, Congress is expected to relax the safe-harbor rules to include hardships created by COVID-19 as part of the CARES Act, which as mentioned above is expected to pass very soon.  We will provide an update as soon as one is available.

In addition, plans are permitted to allow hardship distributions for events that do not satisfy one of the safe harbors, provided that the distributions are required to alleviate an immediate and heavy financial need and that the event is clearly set forth in the plan document.  Therefore, provided that an employer is comfortable deviating from the IRS’s safe harbor and the plan’s third-party administrator can accommodate, it is possible for a plan to be amended to add a hardship withdrawal right in connection with COVID-19.

Are other distributions available to plan participants?

Of course, if you terminate employees in connection with COVID-19, then your plan likely permits the distribution of their full vested account balances.  For employees who are not terminated, your plan may permit employees to take in-service distributions of their 401(k) elective deferrals upon reaching age 59-1/2.

Did the IRS extend the time that excess deferrals (and income) must be distributed from a 401(k) Plan to a date later than April 15, 2020, in order to exclude the distributions from income?

UPDATED (April 1, 2020): No, the April 15, 2020 deadline to distribute excess deferrals in order to exclude the distributions from income is not extended.

Defined Benefit Plans

We are considering freezing or reducing benefit accruals under our defined benefit plan as a result of COVID-19.  What do we need to do?

If you want to amend your plan to reduce or eliminate accruals, then you are required to send out a 204(h) notice, which explains the change, at least 45 days before the change takes effect.  Benefit accruals may also slow simply by virtue of reduced hours, which does not require any notice. Where employee compensation or hours of service are part of the formula for determining benefits, furloughing employees or reducing their hours will cut the rate at which benefits accrue.

If we take certain actions as a result of COVID-19, will we be required to notify the Pension Benefit Guarantee Corporation (PBGC)?

Under PBGC rules, employers that offer defined benefit pension plans are required to notify the PBGC if certain reportable events occur.  Notification to the PBGC may be required in advance of or following the reportable event.  Reportable events that could occur in connection with the COVID-19 pandemic include, but are not limited to:  active participant reductions, failure to make required pension plan funding payments, or insolvency.  An active participant reduction can occur in the event of a mass termination, where active participants in a plan are reduced to at least 80% of what they were at the beginning of the year, either as a result of a single event or terminations occurring overtime during the year.

In addition to reportable events, defined benefit plan sponsors are also required to notify the PBGC when an employer ceases operations at a facility and such cessation results in a workforce reduction of more than a 15% reduction in the number of employees eligible to participate in the plan.

If you are considering actions that could fall into one of these categories, you should contact your plan counsel to determine if filing exceptions exist and to assist in preparing any necessary filing.

If a reportable event occurs as a result of the COVID-19 pandemic, could this impact any of my company’s credit agreements?

Yes.  Credit agreements typically include a host of representations and notification requirements related to reportable events.  So, if a reportable event is expected to occur as a result of the COVID-19 pandemic, then your company’s credit agreement could be impacted and should be reviewed as soon as possible.

As further COVID-19 legislation is passed and as agencies provide further advice on how to operate benefit plans, we will continue to provide guidance for plan sponsors. If you have any questions about the information in these Q&As, please contact any of our employee benefits attorneys.