The current economic uncertainty due to the ongoing COVID-19 pandemic and high levels of inflation across the board has led plan sponsors to consider cost-cutting options. Historically, employer contributions to 401(k) plan accounts are high on the list of options when times are tough. In fact, during the global financial crisis of 2008 employer matching contributions processed by one of the largest recordkeepers in the business fell by 12%.
Related Read: Is Your Plan’s Matching Contribution Formula Delivering Results?
Plan sponsors need to weigh the pros and cons before making a decision, in the context of other cost-cutting alternatives they might have. Here are some factors to consider:
The primary positive of suspending contributions is that it allows plan sponsors to free up cash to pay bills that must be paid, including payroll. In a perfect world, contribution suspensions would be a rare event. Another possible positive is that, if contributions are suspended now after the initial participant shock wears off (and if plan sponsors are able to resume contributions in a few months), any future contribution suspension might be less traumatic.
A key negative regarding suspending contributions is that employee morale may take a hit at a time when plan sponsors need employees to be as motivated as ever to help companies navigate through the current economic rough patch. There is also the possibility that some participants will follow suit and choose to suspend their deferrals and then fail to resume them when times get better — a significant setback to employee retirement preparedness.
Considerations for safe harbor plans
Plan sponsors with safe harbor plans could face a different challenge if their primary contributions are nondiscretionary and are needed to avoid being subject to nondiscrimination testing. Suspending those contributions will subject the plan to nondiscrimination testing and possibly failing the tests. In this scenario, voluntary deferrals by higher-paid employees would need to be reduced significantly (and potentially returned to the highly-compensated employees) to clear the nondiscrimination testing hurdle and allow the plan to pass the nondiscrimination testing.
Another negative for safe harbor plans is the need to amend the plan document to reflect the change and wait until the subsequent plan year to put the suspension into effect. However, a midyear contribution suspension may be possible if two conditions are met:
- Before the beginning of the plan year, the safe harbor notice to participants stated the possibility of a midyear contribution reduction or suspension; and
- The company has been operating at a loss.
Safe harbor plans that drop their safe harbor status must amend their plan documents to require nondiscrimination testing. Plan sponsors will need to make another plan amendment to return to safe harbor status in the future.
Clear communication is critical
If plan sponsors are considering a contribution suspension, how they communicate the decision is critical. In general, it is good to cover why the decision was made and what other measures are being taken to address the company’s financial strains. Finally, plan sponsors should explain whether they anticipate restoring the contributions down the road.
However, the future is hard to predict — plan sponsors should be careful not to make it sound like a promise. Instead, plan sponsors should be clear about what conditions will be required before contributions can be restored to help avoid any unrealistic expectations among participants.
Sponsors of non-safe harbor 401(k) plans also have notification obligations for planned contribution reductions and participants must be given at least a 30-day notice. This will allow participants an opportunity to increase their deferrals to offset the loss of the employer match.
In closing, suspensions of employer matching and/or nondiscretionary contributions do not have to be permanent. It is in both the plan sponsor’s and employee’s best interests to restore these contributions when the time is financially right.
If you have any questions, please contact Ken Kobiernicki or your ORBA advisor at 312.670.7444. Visit ORBA.com to learn more about our Employee Benefit Plans Services.