The coronavirus pandemic has placed unprecedented challenges on employers, as we have seen companies being forced to implement layoffs and furloughs and navigate financial constraints from decreased revenues and profits. It has become clear that the COVID-19 health crisis has brought and will continue to bring significant economic disruption, which means that employers need to confront the challenges related to their 401(k) plans. Many organizations have been coming up with ways to prudently manage their budgets and expenses, and one topic that deserves attention is the flexibility surrounding changes to employer-sponsored retirement plans with respect to the employer match, profit-sharing, and discretionary contributions.
As a retirement committee member or leadership of an organization, here are some of the things you should consider in terms of your company’s retirement plan during an economically challenging time like the one we are facing.
Identify the overall cost of your organization’s contribution on an annual basis.
You want to understand this cost in connection to your annual payroll expenses. For example, there may be other areas within your company’s budget and expenses that can be cut or refined to provide your organization with just as much financial benefit without having such a direct impact on your employees and your employee benefits package. When weighing the decision to cut or trim your employer match, ensure you think of this decision in the constructs of your employee benefits and what that means in terms of your overall compensation package.
Assess your employer matching or discretionary contributions in comparison with industry trends and peers.
Let’s say in your company plan, you are matching dollar-for-dollar up to 5%, and among your peers and competitors, the average match is dollar-for-dollar up to 6%. In this scenario, even if you could save several hundred thousand or even millions of dollars by cutting your matching contribution, you need to consider the fact that you are already below your peer group benchmark when it comes to benefits. That short-term cost savings may not only decrease the benefit you are providing your employees but may also put you at a competitive disadvantage for however long you decrease or suspend your match. Although the latter may involve a relatively short timeframe, and the deduction or suspension may help you financially for the current year, you need to weigh the effect over the next several years. A reduction in benefits can quickly and significantly impact your ability to retain and attract highly skilled talent, which in turn can trigger a domino effect of negative setbacks in terms of productivity and financial goals for your organization.
To summarize these two points: think about your retirement plan costs in connection with your overall compensation package to determine whether that’s an area you are truly willing to adjust or cut and consider how your match compares to that of your industry peers. You want to be sure that when you make adjustments, you recognize the toll it can take on your competitiveness with industry peers. This current economic environment is quite unique in that we are seeing companies do everything necessary to maintain some semblance of operations and the ability to pay their employees. Although this pandemic has unique challenges that set it apart from typical economic downturns, this epoch helps us put a lens on how organizations may want to think about their retirement plans, employer matches, and discretionary contributions if and when there is a recession in the future.
Keep in Mind: Compliance Protocols
When it actually comes to making changes to your employer contribution, there are several housekeeping items to take note of.
- Know whether your contribution is stated in your adoption agreement or written as a discretionary contribution.
An organization may either list a match of 100% up to 5%, for example, in its plan document or what’s called an adoption agreement, or it may give a match of said 100% up to 5%, which it has done since the company’s beginning, but in the adoption agreement, this match is listed as discretionary spending, so it is not specifically written into the adoption agreement. This difference is relevant because if you have a written match in your adoption agreement, to suspend or alter that match, you have to amend your plan document, which usually takes between 15-45 days to finalize. Additionally, once you revise the plan, you have to provide employees with a 30-day notice regarding the change, meaning it may take up to two or more months to actually change your plan’s match or employer contribution if it’s written into the plan.
If you have a discretionary match, you may internally state what the match is through employee offer letters and benefits packages, but for legal purposes, that match is listed as discretionary in your plan document. In this case, you can change your match without amending your plan, and then typically simply need to supply a 30-day notice regarding the change to your employees. Because the match is listed as discretionary, there is a gray area around whether you need to provide a 30-day notice or not, but doing so is best practice.
- There are a number of organizations that use the matching or employer contribution to pass year-end compliance tests or non-discrimination tests.
Many organizations provide a certain type of matching or employer contribution, called a safe-harbor match or a safe-harbor non-elective contribution, to pass those tests, and there are technically only specific circumstances in which you can stop a safe-harbor contribution because it is communicated to employees before the plan year starts. Through a safe-harbor notice, an organization states to employees that the safe-harbor contribution will be made for the entire year, meaning that to suspend or alter the contribution, you as the employer must meet one of the following two criteria:
- Provide language in the safe-harbor notice given before the plan year started that says the employer can stop or suspend the safe-harbor contribution at any time.
- Prove and maintain documentation that your organization is facing significant financial hardship and is operating at a financial loss.
If your organization meets one of these criteria, you can then amend your plan and provide notice to all employees. Note that this process may take 60+ days. Additionally, if you stop or suspend a safe-harbor contribution in the middle of the year, your organization will be required to perform the year-end testing that you were previously given a pass on because of your safe-harbor contribution. Failing these tests may require you to limit how much highly compensated employees can contribute to your plan, and you may need to provide refunds from the plan to these employees if limits have been exceeded.
At AFS, we help retirement committees and finance executives at organizations carefully think through and evaluate these decisions by benchmarking their plans and matching contributions, and determining how they compare to industry peers. We ensure our clients are equipped to prudently determine if their employer match is an area they are willing to or need to adjust and help them process the implications any changes will have for their employees and competitiveness in the marketplace. This involves us running analyses to help our clients understand the total annual budget or capital cost for their employer contribution and the amount of savings they would generate on an annual and down to a monthly basis if they were to stop or suspend the match during a certain period.
Currently, the trade association for our industry, the National Association of Plan Advisors (NAPA), and its parent organization, the American Retirement Association (ARA), are advocating for temporary reprieve in the form of congressional and Department of Labor action that would ease some of the rules around stopping or suspending a match. The ARA’s main concern is organizations terminating their retirement plans altogether because of the financial constraints triggered by the coronavirus pandemic. Knowing that we are currently facing unique challenges, the ARA would rather provide some protection for an organization and allow it to suspend its match temporarily without having to navigate the lengthy compliance protocols in hopes that the organization can reinstate the match sooner with less overall risk to its employees and employee benefits packages.
Ultimately, our goal is to create high-quality and valuable retirement programs that allow your organization to attract and retain world-class talent and help employees get and stay on track for a lifetime of financial success. Matching and employer contributions are a key component to this; however, we recognize that the current – quite extraordinary and difficult – period means we need to be thoughtful around managing your benefits in a way that maintains the sustainability of both your organization and your employees.