Keep Calm but Know the Options About 401(k) Contributions04/29/2020
The impacts of the COVID-10 pandemic will be felt for years. Employers and employees are both looking for ways to deal with and reposed to the financial stress caused by the cononavirus-induced economic slowdown and market volatility.
If your company’s revenue has plummeted, you have to make some difficult financial decisions, including the possibility of eliminating or scaling back your contributions to employees’ 401(k) accounts. Here’s what you should know before making any cuts.
Without a Safe Harbor Plan
Generally, employers can stop contributing to employees’ 401(k) plans, but they must jump through some procedural hoops. If you don’t have a “safe harbor” plan and your plan document allows for suspending contributions, you’ve got some latitude.
Recall that the “storm” that you’re sheltered from in a safe harbor 401(k) plan is the kind of storm where you fail IRS discrimination tests. The tests’ purpose is to prevent an excessive proportion of the 401(k) plan’s benefits from going to business owners and executives, relative to everyone else.
Without a safe harbor plan, while you can drop your contributions easily enough, you’re still subject to discrimination testing – as you always were. Just be sure to comply with whatever notification and other requirements your plan document calls for.
Safe Harbor Rules
If your 401(k) uses a safe harbor design, it could get more complicated. Remember, that to get safe harbor status, you had three plan design options:
- To match what employees put into their accounts (the “deferral” amount) dollar-for-dollar up to 3% of their income, plus a 50% match on any savings amounts between 3% and 5%.
- To provide an “enhanced match” that simplifies the first matching formula. An example of an enhanced match is 100% on deferrals up to 4% of the employee’s pay.
- To offer “non-elective” contributions to employees’ accounts equal to at least 3% of their earnings, no matter what, if anything, they put in on their own.
If your safe harbor plan document already states that you reserve the right to suspend your contributions for any reason, you can do so in the middle of your plan year. However, you’ll be subject to discrimination testing.
If your plan document doesn’t include a mid-year suspension provision, IRS regulations allow you to drop (or reduce) contributions only if your business is losing money. In addition, for a mid-year suspension in this scenario, you need to amend your plan document accordingly and formally notify employees of this at least 30 days prior to taking any action.
If the safe harbor matching formula you’re using was the matching variety, employees must be given a chance to change their deferral amount. You must provide them with this opportunity even if they wouldn’t be allowed to make changes under the terms of your plan in normal circumstances. Your plan also will be subject to discrimination testing.
Monitor Plan Investments
Whether or not you decide to suspend 401(k) matching and nonelective contributions as a belt-tightening measure, you should still focus on other aspects of the plan. For example, you need to closely monitor how your plan investment options are performing.
Compare your plan’s performance with the objectives and strategies articulated by the fund managers when you decided to incorporate them into your plan. If you discover that they haven’t kept up with these expectations, you’ll need to consult with your advisors and respond appropriately.
With most investments tanking in the current environment, it’s natural for employees to be rattled. The degree to which they really should be alarmed will vary according to their circumstances. Many may take drastic action to escape the volatility when they’d probably be better off by just sitting tight. Read our recent blog post called Viewing Current Market Trends through a Historical Lens for further thoughts on this topic.
Right for You?
Desperate times sometimes call for desperate measures. Responsible employers want to do everything possible to help relieve their employees’ financial stress during the COVID-19 pandemic. But they also need to keep the business afloat — so employees have a place to return to work after the dust settles.
Cutting back on 401(k) contributions can temporarily free up cash flow to help businesses stay alive. To evaluate whether this could be a smart move for your business, contact us to discuss your situation and options.