COVID-19 has Throttled the Economy into a Recession. Now What?

COVID-19 has Throttled the Economy into a Recession. Now What?

March 20, 2020
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During times of extreme economic volatility, questions regarding your retirement plan may come to the forefront.  Some of these may include:

  • Increases in request for in-service distributions
  • Issues related to layoffs
  • Suspension or Termination of employer allocations

Below are some quick points on each of these matters that may help you navigate the upcoming storm.  If you need additional guidance, or have any questions, please let us know.

Increase in request for in-service distributions

Q:  We have had an increase of current employees asking about accessing their retirement funds.  What are their options?

A:  It is important that plan sponsors review their plan document to be aware of all available options as they should be defined in the document (if you need help deciphering these options please let us know).      

Q:  I see hardship distributions are an available option. Can you provide more information on this?

A:  A hardship distribution is a plan provision that allows a current (and possibly former) employee to access their participant account for certain pre-approved reasons. The amounts requested must be for no more than the immediate need and proof of hardship must be provided. These requests can also be limited to certain sources of a participant’s account, so it is important that you review the document for any of these restrictions.

Note that a hardship is still treated as a distribution from the plan and will be subject to taxes and, depending on the participant’s age, early withdrawal penalties.

Q:  What are the pre-approved reasons?

A:  The following are the currently approved reasons:

  • expenses for medical care (described in Section 213(d) of the Internal Revenue Code) previously incurred by you, your spouse or your dependents or necessary for you, your spouse or your dependents to obtain medical care.
  • costs directly related to the purchase of your principal residence (excluding mortgage payments).
  • tuition, related educational fees, and room and board expenses for the next twelve (12) months of post-secondary education for yourself, your spouse, or your dependents.
  • amounts necessary to prevent your eviction from your principal residence or foreclosure on the mortgage of your principal residence.
  • payments for burial or funeral expenses for your deceased parent, spouse, children or other dependents.
  • expenses for the repair of damage to your principal residence that would qualify for the casualty deduction under the Internal Revenue Code.

Q:  I heard there were additional restrictions placed on participants when they take a distribution.

A:  Historically, yes there have been additional restrictions placed on participants who took a hardship.  The biggest of these is that a participant would be suspended from deferring into the account for up to 6 months. However, this provision is no longer applicable and any employee who takes a hardship can continue to defer into the plan.

Issues related to layoffs

Q:  We may have to lay off a large number of employees. What ramifications could that have for the plan?

A: This could affect employer allocations and related testing. It also could trigger a partial plan termination if more than 20% of your total plan participants were laid off in a particular year.

Partial terminations can occur in connection with a significant corporate event such as a closing of a plant or a division, or as a result of general employee turnover due to adverse economic conditions or other reasons that are not within the employer’s control. The law requires all affected employees to be fully vested in their account balance as of the date of a full or partial plan termination. They must become 100% vested in all employer contributions (including matching contributions) regardless of the plan’s vesting schedule.

Q:  What about the terminated participants with a loan?

A:  It is important that the participant reviews the terms of the loan. It will include language regarding what happens to the loan once an employee terminates employment.

What typically will happen, absent paying off a loan in full or rolling over to another qualified plan (this option is allowable but not frequently used as both parties must allow), is the loan will “default”.  The term default is a bit of a misnomer because in reality the outstanding balance of the loan is recoded as a deemed distribution. This can have serious tax consequences for a participant as this deemed distribution would be considered taxable income and, depending on the participant’s age, may be subject to early withdrawal penalties.

Suspension or Termination of Employer Allocations

While we would not traditionally recommend that employers suspend any employee benefits, we also understand that times of severe uncertainty, it has been a necessary short-term step for the long-term success of the business. If you are seriously considering this option, please let us know and ensure you have reviewed all the pros & cons of such a decision.

Q:  Do you have options if you’re afraid you can no longer afford to continue making your current employer allocation?

A:  Yes, depending on how these allocations are defined in your document, your plan may have several available options:

Q:  My plan is a safe harbor plan. I am under the assumption that I cannot change this allocation during the year.  Is this correct?

A:  While this certainly used to be the case, the rules for removing a safe harbor provision mid-plan year have become more relaxed, but they do come with some drawbacks.

Terminating a safe harbor provision (non-elective or match) can be done mid-year via a plan amendment. There are some additional stipulations you should know about:

  • The amendment must be announced at least 30 days prior to the effective date.
  • Safe Harbor provisions will be in place up to the effective date. For example, you decide to make the change April 1, notice is provided, and the safe harbor allocation stops as of May 1. The plan will owe the equivalent safe harbor allocation up to that date.
  • The plan loses the ADP/ACP testing protections for the entire plan year. This means the plan will be subject to ADP / ACP testing for the entire plan year. Note that year-to-date safe harbor allocations would be included in testing.

Q:  If my plan is not safe harbor and I need to change my match allocation, what do I need to do?

A:  The answer to this will vary depending on how your current plan provision(s) regarding these allocations are written.   

If the plan has a purely discretionary match, there should be no amendment needed in order for the plan to change the current match formula or stop the match entirely.

If the plan document has a defined match allocation that is expressed in the document, a formal amendment would be required but a few factors would also need to be considered.

The determination / calculation period for the match:

Pay Period: this means the match is determined and calculated per pay period.

The plan may be able to change the match allocation by amending the plan document. Under this scenario, we would recommend amending to a purely discretionary match. As mentioned above, this would allow a plan to stop, start, or change the match formula at the discretion of the plan sponsor.

Annual Determination: this means the calculation is based on annual compensation related to annual deferrals. This is independent of a sponsor funding entirely at the end of the plan year or “fund as you the go”.  Under this scenario, there are a couple of other factors that come into play. Does the plan have any year end requirements to share in the match such as a 1,000 hour or employed on the last day of the year?

If the plan has a requirement that an employee has to be employed on the last day of the plan year, the plan can be amended at any time prior to the end of the plan year as no benefit has accrued.

If the plan does not have a last day rule but a 1,000 hour requirement, the plan can amend up to the point where any employee has worked 1,000 hours or the equivalent of. Once a person works 1,000 hours, the benefit has accrued and cannot be amended.

If the plan has neither, it can be amended up to the point where any employee works at least 500 hours or the equivalent of. Once a person works 500 hours in this scenario, a benefit has accrued cannot be removed.

 

Q:  What about year-end “profit-sharing” allocations, is that any different?

A:  Most of these allocations are completely discretionary but as mentioned above for annual match, you may still be limited on amending the requirements to share in the allocation.

 

While we sincerely hope your company is not faced with these concerns, we hope this helps provide guidance should you be faced with any of these situations. Please do not hesitate to reach out to us if we can assist with any of these issues or others as they arise. 

Also, keep checking back into our blog for continual updates. In extreme times, the IRS & DOL have expanded some options regarding plan distributions that may come into play for your plan.

 

This information is not intended as authoritative guidance or tax or legal advice. You should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.