CARES Act Retirement Plan Considerations for Employers
The CARES Act contained a number of relief provisions that may generate additional cash flow and tax savings associated with employer retirement plans. In addition, as employers adjust to the new normal and focus on 2020 tax planning, many who decreased or eliminated employer contributions are considering increasing or reinstating those amounts.
Specifically, employers can adjust certain plan contributions and consider different plan designs and/or investment approaches to eliminate or mitigate investment risk. Additionally, in light of the difficulties due to COVID-19, the IRS and DOL are providing flexibility regarding plan notices and the requirement to have documents notarized or witnessed by a plan representative.
Finally, any employer who has had to furlough or lay off workers should be cognizant of the partial plan termination rules. If a plan experiences a partial termination, affected employees vest in unvested contributions, an event which can increase the need for employer contributions to plans.
Delay or Elimination of Plan Contributions
Some employers want to delay or eliminate contributions to retirement plans as long as possible. The CARES Act allows plan sponsors to delay until January 1, 2021, any defined benefit plan contribution otherwise due in 2020. This applies to annual contributions with a final due date occurring in 2020 and any quarterly contributions due during 2020. Note that taking advantage of this delay does not change the requirement that amounts be made by the income tax return due date for deduction purposes.
Delayed contributions must include interest from the contribution’s original due date, at the plan’s effective rate of interest for the plan year. If more than a delay of a pension contribution is needed, employers can request a waiver of the funding requirement. Waivers are typically granted if the employer cannot make a required contribution and it is expected that the inability to fund current required contributions is a temporary phenomenon. Underfunded defined benefit plans are also provided relief in that a plan’s adjusted funding target attainment percentage (“AFTAP”) for 2020 plan years is deemed to be equal to the AFTAP for the last plan year ending before January 1, 2020.
Depending on plan language and actions the employer has taken, discretionary contributions to profit sharing or 401(k) retirement plans may be eliminated or reduced. The ability to do this will depend on the specific plan of the employer. If current plan language does not accommodate reduced or eliminated contributions, plan amendments may be possible. In addition, one could decide to reduce such contributions only for highly compensated employees.
Employers planning to amend plans to eliminate future required contributions or freeze future benefit accruals need to be careful not to eliminate a participant’s accrued benefit. Thus, if the plan is drafted to provide a matching contribution for all salary reduction contributions, such amendment cannot apply to matching contributions for salary reduction contributions that have already been made. If a profit sharing contribution is required to be made to plan participants employed on the last day of the plan year, an amendment could be made to eliminate that nondiscretionary contribution as no employee accrues that benefit until the last day of the plan year.
Safe harbor 401(k) plans generally cannot reduce contributions mid-year without becoming subject to the annual nondiscrimination tests and providing notice to participants within a reasonable period of time before the effective date of the change. IRS Notice 2020-52 provides relief for certain mid-year amendments made between March 13, 2020, and August 31, 2020, but does not apply to reduction of safe harbor matching contributions because those communications often affect employee decisions regarding elective contributions.
Changes to Plan Designs and/or Investment Approaches
Most defined benefit plans transfer investment risk to the employer by providing a stated annual benefit to plan participants. A variable annuity plan is unique in that the plan design limits the employer’s investment risk while still providing annual contributions based on an individual’s age and a promised retirement benefit. Employers offering a defined benefit plan to employees should consider the adoption of a variable annuity plan to limit contributions as plan investment return declines, while still maintaining significant retirement savings for older, more highly compensated workers. In preparation for shifting to such a plan design, employers may want to consider termination of existing plans in 2020.
Reinstatement or Increases in Plan Contributions
In adjusting to the new normal and focusing on taxes due for 2020, some employers are considering making additional discretionary contributions to a qualified plan. Assuming a plan allows for discretionary contributions, employers still have up until the due date (including extensions) for the current tax year to make a contribution, treating it as if it was made to the plan during the current tax year and deducting it on income tax return for the current tax year.
Employee Elections and Employer Notices
Certain participant elections are required to be witnessed by a plan representative or a notary public. This includes, among other things, spousal consents. IRS Notice 2020-42 provides temporary relief from the requirement for any participant election witnessed by a notary public in a state that permits remote electronic notarization and any participant election witnessed by a plan representative. In both cases, live audio-video technology must be used. DOL Notice 2020-01 provides that a plan sponsor will not violate ERISA for failing to timely furnish a notice, disclosure, or document that must be furnished between March 1, 2020 and 60 days after the announced end of the COVID-19 National Emergency so long as the plan sponsor acts in good faith and furnishes such notice, disclosure, or document as soon as administratively practicable under the circumstances.
Partial Plan Terminations
Many retirement plans include vesting schedules which require employment over a number of yeas for full vesting. When a plan terminates or partially terminates, affected participants vest in their plan benefit to the extent funded.
A partial termination occurs when there is a significant reduction in employees due to involuntary severance. This is a facts and circumstances determination, not a reduction of a specified number of employees. In fact, many times, a partial termination develops over a number of months in a plan year, as the employer experiences a series of cutbacks.
Rev Rul 2007-43 provides a rebuttable presumption stating that a partial plan termination occurs if there is a 20% reduction or turnover of plan participants during an applicable period. An applicable period is a plan year, but may include more than plan year. Due to the pandemic, terminated employees who are rehired in 2020, voluntary terminations, terminations for cause, retirements and terminations as a result of death or disability are not counted in the 20% test. Voluntary terminations, while not included in the 20% test, are still considered an affected participant for vesting purposes if a partial plan termination is determined to have occurred.
Employers who have terminated employees and not been able to rehire those individuals, should evaluate whether layoffs and furloughs have been significant enough that a plan has been partially terminated. Although an employer can file a Form 5300 to request an IRS determination of this, many will make this determination themselves. To do so, it is important to document the facts surrounding the employer-initiated termination of employment to support the classification of workers as affected participants and the applicable period for determining if a partial termination occurs.