Protecting the health of retirement plans from COVID-19, Part III: Administrative and fiduciary issues for retirement plans
The COVID-19 crisis is creating major upheavals both in terms of people’s health and their retirement benefits. Employers and their employees are struggling to handle the stock market’s drastic downturn, the challenges of working remotely, the negative impact of declining business or total shutdown, and the isolation of sheltering in place.
Unfortunately, the coronavirus is also having a direct or indirect impact on an employer’s retirement plans. In part three of this three part alert, we will examine how to address the effects of layoffs, Family First Coronavirus Response Act (FFCRA) payments and the stock market decline. Part one addressed how an employer can stop or reduce its contributions to its retirement plans, and part two explored how employees may gain access to their retirement assets to handle the current financial struggles.
Workforce reductions create administrative issues
Due to the orders to either shut down operations to create social distancing or just the severe economic decline, employers are reducing staffing levels or cutting back hours of work. These approaches to handling the reduced demand for labor have a direct and indirect effect on the employer’s retirement plan operations.
Perhaps the most immediate issues created for retirement plans when employers reduce staff is the potential for a “partial termination of the plan.” There is no precise definition of a partial termination of a plan under ERISA, but the Internal Revenue Service (IRS) has indicated that when 20% or more of an employer’s workforce is terminated involuntarily there is the possibility that a partial termination of the plan has occurred. If there is a partial termination of the plan, then ERISA requires the affected participants to become 100% vested. The participants who have not terminated do not need to be vested.
The partial termination concept is designed to address situations where the employee is unable to work and progress along the plan’s vesting schedule due to actions the employer has taken. Of course, employers may always let people go. The concept only becomes applicable when larger numbers are affected. The action does not have to be a single event. The IRS has indicated that the 20% threshold may be reached in a series of events. For example, a single lay off event may not reach 20% but when all the layoffs are considered over a period of time the threshold might be met. It is also not clear how long that period might be. The IRS has on occasion considered terminations over multiple plan years as being one partial termination event because they all resulted from the same set of facts.
The partial termination concept affects employers of all sizes. In a large employer, the number of people who need to be terminated before it is an issue could be large. But in a small employer, a layoff of two or three people could trigger a partial termination of the plan as it relates to those laid off employees. Those laid off employees must be vested.
A related question of course is whether an “a laid off” employee is terminated for these purposes. The answer is probably a facts and circumstances matter. If the employee is laid off but recalled in a relatively short period of time, the employee was probably not terminated.
Given the fluid nature of the economic conditions and the possibility that laid off employees may be returned in the short run, it may be best to wait until closer to the end of the plan year to determine whether a partial termination has occurred and whether individuals need to be vested.
Employers are best advised to be aware that actions to cut back on their workforces may have an unexpected and unanticipated consequence.
401(k) and plan loan deposits
ERISA requires employers to deposit 401(k) contributions and plan loan repayments relatively quickly into the 401(k) plan. Failure to deposit as soon as possible, but not later than the 15th business day of the month following the month of the 401(k) deferral or loan repayment, is treated as if the employer had borrowed those funds. This type of borrowing is a prohibited transaction under ERISA and the fiduciary who lets it happen has breached his fiduciary duty.
As cash flow needs become more pressing, the employers need to resist the temptation to hold on to the 401(k) contributions and loan repayments longer than necessary in order to satisfy its own cash flow needs.
Distributions from 401(k) plans
The Tax Code prohibits a 401(k) plan from distributing an employee’s 401(k) salary deferral contributions and certain other contributions like Safe Harbor Contributions or Qualified Nonelective Contributions while the employee is still working. Distributions after age 59 ½ of those contributions are permitted.
The question then becomes is a “laid off” employee terminated so that he or she can request a distribution or are they still employed and are unable to receive a distribution before age 59 ½ . It has no easy answer. It would seem to turn on how “permanent” they lay off is. If the employer reasonably expects to bring the employee back within a relatively short period of time, it is probably safer from the plan’s perspective to treat the lay off as not being a termination.
However, if the employer is using the term “lay off” as a softer term to describe termination and it does not appear that the employee is going to be called back, perhaps it is a termination.
As a method of easing the financial strains on employees who are required to take time off from work due to having contracted COVID-19 personally or to assist a family member who has been affected, Congress passed and the president signed the Families First Coronavirus Response Act (FFCRA). This act will require some employers to provide paid time off when they might never have done so before. Such payments will be effectively W-2 income. As such, the payments will typically be considered compensation for retirement plan purposes. This means 401(k) contributions will be taken out unless a participant elects otherwise following the plan’s normal rules for changing a deferral election. Additionally that compensation will be included in calculating any employer contributions.