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The Pandemic and Your Retirement Plan: Re-examine Plan Design in Light of COVID-19

Posted by Wende Wadsworth, CPA on Dec 22, 2020 12:03:25 AM

Reitrement 2020The coronavirus pandemic has resulted in financial upheaval for a number of businesses that sponsor an employee retirement plan. As a result, some of them have taken a fresh look at their plan design to see if there are any changes that could help them better weather the financial storm.

Following are some areas of plan design that you might want to take a fresh look at.

Replace Safe Harbor with Discretionary Contributions

One plan design change that could be beneficial is to eliminate a safe harbor mandatory employer contribution and instead make matching employer contributions discretionary. This will give you more financial flexibility to deal with income disruptions your company might be facing due to the pandemic.

To recap: With a safe harbor plan design, you’re required to contribute a minimum amount (usually 3 percent of salary) to participants’ accounts each pay period. Participants then become fully vested in these matching contributions immediately. By adopting a safe harbor design, your plan doesn’t have to pass annual non-discrimination tests, which may enable highly compensated employees (HCEs) to contribute more money to their accounts than they could otherwise.

IRS Notice 2020-52 states that plan sponsors can eliminate safe harbor 401(k) contributions for HCEs only and still retain the plan’s safe harbor status as long as safe harbor contributions continue to be made for non-highly compensated employees. Therefore, you might consider suspending safe harbor contributions just for your HCEs if your finances allow this, which would enable you to retain the benefits offered by safe harbor status.

Re-examine Definition of Eligible Compensation

Sponsors often adopt a prototype plan with standard language regarding eligible compensation for deferrals and employer contributions, such as gross compensation with no exclusions. However, if your employees receive non-standard pay—such as bonuses, gift cards, and allowances—or non-cash stock compensation, this can cause problems.

While these forms of compensation are not excluded from the definition of eligible compensation, payroll administrators often exclude them in practice. This results in missed contributions and potentially costly corrective action by the plan sponsor.

Now would be a good time to take a close look at your plan’s definition of eligible compensation for deferral. Make any changes in terms of including or excluding compensation that make sense for your employees and your plan.

Eliminate Waiting Periods and Vesting Schedules

It’s no secret that employees tend to change jobs more often today than they did in the past. In fact, the average employee tenure at a job is about four years, according to the Bureau of Labor Statistics (BLS).

However, many plans still include vesting schedules for receiving employer matches that keep shorter-term employees from receiving the full amount of these matches. As a result, employees who change jobs frequently could end up losing thousands of dollars of matching funds and earnings over the course of their careers, which could significantly affect their retirement readiness.

For example, if a plan has six-year graded vesting and an employee leaves after two years, he will only be vested at 20 percent. If his employer match total is $2,000 when he leaves, he’ll receive just $400 and forfeit $1,600.

Similarly, some retirement plans include waiting periods of up to six months before new employees are eligible to participate in the plan. Forcing new employees to wait this long before they can join a plan may discourage them from ever participating—even after they become eligible.

Given these trends, you may want to consider changing your plan design to eliminate waiting periods and vesting schedules to receive employer matches. More than one-third of plan sponsors are now offering immediate vesting of employer matching contributions, according to a survey conducted by the Plan Sponsor Council of America.

Add Auto-Enrollment and Auto-Escalation

These features have been proven to increase plan participation levels and boost employee deferrals. With auto-enrollment, new employees are automatically enrolled in the retirement plan when they’re hired—they must opt out if they don’t want to participate. And with auto-escalation, employees’ contribution percentages are automatically increased each year—for example, by one percentage point until the deferral reaches 10 percent of pay.

Nearly one-third of employees who participate in a plan with auto-escalation contribute at least 10 percent of their pay to their plan, according to the Defined Contribution Institutional Investment Association. This compares to just one-fifth of employees who participate in a plan that doesn’t feature auto-escalation.

Prepare for the Future

Plan now to meet with your governance group and third-party administrator to discuss whether you should make changes like these to your plan design in light of the pandemic or for any other reason. Doing so could better position your plan and your business for the future.

Deadline for Amending Retirement Plan
to Reflect CARES and SECURE Act Changes

The Coronavirus Aid, Relief, and Economic Security (CARES) Act that was signed into law in the spring contained a number of provisions affecting qualified retirement plans. For example, qualified participants are able to take penalty-free distributions from their retirement accounts and borrow up to $100,000 from their plans in 2020. In addition, required minimum distributions (RMDs) from traditional IRAs and 401(k)s were suspended for 2020.

Given the urgency caused by the pandemic, sponsors were allowed to adopt these provisions right away without having to immediately adopt authorizing plan amendments. You have until December 31, 2022 (or until the end of the plan year that starts in 2022 for non-calendar year plans) to adopt plan amendments to reflect these changes.

The same deadline applies to adopting plan amendments to reflect retirement plan changes made as a result of the Setting Every Community Up for Retirement Enhancement (SECURE) Act that was passed at the end of 2019. For example, the SECURE Act requires that long-term, part-time employees be allowed to participate in 401(k) plans, effective for plan years beginning after December 31, 2020.

Topics: Audit & Assurance

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