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Protecting Retirement Plan Participants and Your Company’s Bottom Line When Employees Return to Work Protecting Retirement Plan Participants and Your Company’s Bottom Line When Employees Return to Work

Protecting Retirement Plan Participants and Your Company’s Bottom Line When Employees Return to Work

After the sudden onset of the COVID-19 pandemic, most plan sponsors were forced to quickly respond to a fundamental change in the economy and how their organizations conducted business. Whether it was the initial economic downturn or switching from an office environment to a completely remote workforce, plan sponsors went into survival mode.

Now that plan sponsors have had a few months to adjust to a “new normal,” many are asking themselves, “Did we do enough to protect our business and plan participants from the pandemic?” With a new surge of infections predicted in the fall, plan sponsors want to know if there is even more they can do with their benefit plan arrangements to protect themselves and plan participants from another economic downturn.

This article provides an overview of the more common retirement plan issues facing plan sponsors along with suggestions for addressing these challenges.
  1. Salary and Bonus Reductions to Conserve Cash
    During this time of uncertainty and financial distress, employers looking to preserve cash flow or avoid layoffs may want to consider a temporary salary reduction program. For “at will” employees, an employer can unilaterally reduce base compensation but only on a prospective basis to comply with state wage and hour laws. Any anticipated salary changes should always be viewed with regard to the potential impact on other benefit programs, such as bonus plans or incentive programs. The impact on severance pay, unemployment insurance and health benefits should also be considered before implementing any changes.

    For employees with an employment agreement, there are additional considerations when implementing a salary reduction program. For instance, most employment agreements require the employee to consent to any changes. Additionally, many employment agreements contain a “good reason” termination definition, which is triggered by a salary reduction, and this could allow the employee to resign and receive a generous severance package that is costly for a plan sponsor trying to conserve cash.

    Although it may be tempting to include a promise to pay back any reduced compensation at some point in the future, plan sponsors can protect the employer’s cash flow by not including such language, especially when the future of the business is unknown.

    Plan sponsors may also consider suspending bonus payments or providing “payment” of annual bonuses into a nonqualified plan. One of the benefits of nonqualified plans is their “unfunded” status. If the employee qualifies for a bonus, instead of being paid cash he or she could receive a “book account” in a nonqualified plan. The book account is not funded from company assets until payment of the benefit, thereby preserving cash. The plan sponsor may even consider adding a vesting schedule for the bonus payment to help with retention.
  2. Furloughs and Layoffs
    A “layoff” typically means a complete termination of employment with no participation in any benefit plans. A “furlough” generally means an employee is on unpaid, non-active status and therefore, not performing any work duties, although there is an expectation of return to full employment in the future. Due to the pandemic, many plan sponsors are choosing to furlough employees so they remain eligible for promised benefits unless the applicable plan terms dictate otherwise.

    This distinction is critical because if self-insured health plans do not clearly provide coverage for furloughed employees, the plan sponsor may end up self-insuring the promised health insurance benefits. Plan sponsors can protect themselves from potential liability by reviewing and confirming the terms of their health insurance contracts and stop-loss agreements. Currently, most insurers are approving benefit coverage for furloughed employees. Plan sponsors should also consider whether the governing documents require amendments to clarify coverage or eligibility provisions.

    Continuing health coverage will also impact a furloughed employee’s COBRA rights. To be eligible for federal COBRA coverage, there must be a triggering event and a loss of coverage. A reduction in hours due to furlough is considered a triggering event for COBRA coverage, even without a termination of employment. However, furloughed employees will not be eligible for COBRA unless and until they lose coverage within the 18-month coverage period.
  3. Partial Retirement Plan Terminations
    Most plan sponsors prefer not to terminate their retirement plans altogether. However, plan sponsors should be mindful that a “partial plan termination” can result when layoffs reduce participant count by at least 20%, or even less in some circumstances. If a partial termination occurs, all affected participants must be fully vested in benefits accrued up to the partial termination date. Affected participants include employees who terminated for any reason during the plan year of the partial termination.
  4. Suspending Employer Contributions to Retirement Plans
    A common method for plan sponsors to preserve cash is to suspend or eliminate entirely the employer contributions to retirement plans. Generally, if the employer contributions are discretionary, the plan sponsor may reduce or eliminate the contributions at any time.  If the employer contributions are not discretionary, then a plan amendment is required, and plan sponsors must avoid impermissible cutbacks of vested benefits.

    For safe harbor plans, there are additional hurdles when suspending employer contributions. Generally, safe harbor contributions are suspended only if the plan sponsor is operating at an economic loss or the safe harbor notice includes language allowing the suspension. Safe harbor plans do require a 30-day advance notice to participants before the mid-year change can be effective. Further, once the change is made, the plan will then be required to perform annual non-discrimination testing for that same plan year.
  5. Retirement Plan Relief under the CARES Act
    Historically, plan participants have been able to access their retirement accounts during times of financial distress while still employed through in-service plan loans and hardship distributions. Hardship distributions taken before a participant reaches age 59½ are subject to a 10% early withdrawal penalty. Plan loan distributions are required to be repaid on a fixed schedule or the participant becomes subject to a 10% early withdrawal penalty.

    Under the CARES Act, plan sponsors have the discretion to adopt several features that provide participants with additional access to retirement savings as follows:

    A. Coronavirus-Related Distributions (CRD).
    A plan sponsor may permit “qualifying individuals” to take a distribution of up to $100,000 from their 401(k) plan or IRA. The typical 10% early withdrawal penalty is waived and the tax associated with the CRD can be paid ratably over a three-year period. An individual may instead repay the CRD back into the plan or another plan, tax-free, within three years from the date of withdrawal.

    B. Increased Loan Limit.
    For qualifying individuals, the CARES Act temporarily increased the plan loan limit from $50,000 and 50% of vested benefits to $100,000 and 100% of vested benefits.

    C. Suspended Loan Repayments.
    For qualifying individuals, due dates for new and existing loan repayments before December 31, 2020 are extended by one year. The interest will continue to accrue on the delayed payments and the loan term can be extended for the delayed repayments to prevent a financial hardship once payments resume.

    D. Relief for Required Minimum Distributions.
    The CARES Act also waived the required minimum distribution rules for 2020 in defined contribution plans for all participants.

    To qualify for a CRD or loan limit adjustment, a “qualifying individual” must meet one of the following criteria:
    • Diagnosed with COVID-19;
    • Has a spouse or dependent diagnosed with COVID-19; or
    • Experiences adverse financial consequences from being quarantined, furloughed or laid off; having work hours reduced; being unable to work due to lack of childcare; closing or reducing hours of a business; or from other factors, as determined by the Treasury secretary.
    Plan sponsors can help protect participants financially by implementing these changes immediately. Plan amendments may be adopted as late as December 31, 2022.
  6. Performance-Based Equity Awards
    The pandemic created many challenges for plan sponsors of performance-based compensation programs. For public companies that set their performance targets during the first quarter of 2020, those targets may now be difficult or even unlikely to be achieved and may not provide the intended performance incentives. Plan sponsors may want to consider whether the plan terms provide flexibility to adjust performance goals.

    To better protect the employer, plan sponsors may decide to postpone establishing performance goals until later in the plan year or not to grant performance awards in 2020. Plan sponsors at public companies will need to be careful that proxy advisory firms (such as Glass Lewis and Institutional Shareholder Services) do not respond negatively if there is not a formal connection between performance and compensation.

    Plan sponsors may also consider using relative performance goals as a preferred metric. With volatile market conditions, it can be difficult to set appropriate performance goals based on the performance of the company itself, but goals that measure performance compared to peer companies may be more appealing to employees.
  7. Repricing of Stock Options or Stock Appreciation Rights (SARs)
    Extreme market volatility due to the pandemic has negatively affected the stock price of many private and public companies. A plan sponsor who grants stock options or SARs may consider repricing stock options to protect the original intentions of these programs, especially if the awards are a large portion of an employee’s total compensation. Underwater options and SARs will lose their retention value if the employee no longer feels he or she will regain value. Generally, repricing is attractive when the exercise price of an outstanding option is higher than the value of the underlying employer stock (i.e., an “underwater” option). Private companies will have more flexibility in determining repricing terms than public companies, which are likely to require shareholder approvals.
  8. Deferred Compensation Plans
    Some plan sponsors may consider changing deferral elections in nonqualified deferred compensation plans to assist their executives with financial obligations. However, cessation of deferral elections made during the current year would be treated as an impermissible acceleration of compensation, which is not permitted under Code Section 409A and would likely create adverse tax consequences to the executive. Due to the pandemic, payments could be accelerated in some cases (such as hardship or an unforeseeable emergency), but any changes should be reviewed closely to avoid any negative tax consequences.

    IRS Notice 2020-50 clarified that if a participant receives a CRD, that distribution will be considered a hardship distribution under Code Section 409A, which would allow the participant to cancel a nonqualified plan deferral election at the same time.
  9. Defined Benefit Pension Plans
    Defined benefit pension plans promise a benefit to participants upon retirement or termination of employment. If there is a large reduction in the pension plan’s assets due to a market downturn, there will be a shortfall in the promised benefits. This funding shortfall may have to be made up by the plan sponsor if it’s significant enough at the time the actuary calculates the annual contribution.

    The CARES Act allows plan sponsors to delay making required cash contributions (including quarterly contributions) due in the 2020 calendar year until January 1, 2021. This delay will help plan sponsors with their cash flow and conserve current funds for other needs during the pandemic.
  10. Fiduciary Considerations for Plan Sponsors
    With additional market volatility during the COVID-19 crisis, plan sponsors may need to hold more frequent retirement committee meetings to review investment fund performance and determine if any changes are needed. The reasons for any fund changes should be fully documented and communicated to plan participants.

    Plan sponsors should continue to review vendors’ fees and expenses and confirm that they are reasonable. Eligible expenses can typically be paid from plan assets. While allocating fees to participants may not seem ideal, it may help the plan sponsor avoid suspending employer contributions to preserve cash.

    Plan forfeitures can usually be used to pay certain plan expenses or offset funding of employer contributions. Since forfeitures typically need to be used each plan year, they may be helpful right now if budgets are tight.
What’s Next?

Many plan sponsors believe the COVID-19 crisis is just getting started and the economic distress may last for months or longer. These circumstances present significant challenges to plan sponsors who want to motivate and retain employees while protecting themselves and the plan participants.

Plan sponsors are facing difficult decisions as a result of the economic impact of the pandemic, including decisions about their benefit plans. Many are being forced to choose between business needs and what is in the long-term best interest of plan participants. Plan sponsors want to provide immediate relief to employees directly impacted by COVID-19, but they are also thoughtfully considering the impact on their employees’ long-term health and retirement wellness.

Plan sponsors can protect themselves and plan participants by revisiting programs that are costly or underutilized. Retirement benefits and medical insurance are often the more costly benefits. As to utilization, low participation rates may indicate employees do not appreciate the offered benefits or are unable to take advantage of them and open the door for plan design improvements.

If budget constraints continue to exist, plan sponsors should seriously consider the options described above to achieve much needed financial relief and at the end of the day, watch your bottom (line)!

If you would like to discuss the impact of the pandemic on your employee benefit plans, please contact Gary Blachman, Austin Anderson or any attorney in our Employee Benefits Group for whom you work.

This publication is intended for general informational purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstance.
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