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Companies looking for ways to reduce their expenses and improve cash flow during the COVID-19 pandemic are asking whether it is permissible to suspend or reduce contributions to their defined contribution retirement plan. As usual, the answer is "it depends."

Suspending profit sharing & money purchase plan contributions

Profit-sharing plans or money purchase plans that promise the company will make a stated contribution amount each year, such as 5% of compensation, can be amended mid-year to change the contribution formula. The amendment can always be applied prospectively with respect to compensation earned after the effective date. For example, if the amendment is effective August 1, 2020, participants would be entitled to an allocation of 5% of compensation earned through July 31, and 0% for compensation earned after July 31.

Many of these plans require that the employee must be employed on the last day of the plan year to be entitled to the contribution. A plan with this "last day" rule could be amended retroactively to the first day of the plan year because no one will accrue the right to the contribution until the last day.

Similarly, many plans require that an employee must complete 1000 hours of service during the plan year to earn the right to the contribution. The plan could be amended retroactively for any employee who has not met the service requirement as of the effective date of the amendment.

Suspending 401(k) matching contributions

A 401(k) plan will have either a fixed matching contribution formula, such as a 50% match per dollar up to 6% of the employee's compensation, or a discretionary formula, which permits the company to decide each year how much it will match that year.

If the plan has a fixed formula, the plan document will need to be amended before the match suspension or reduction can go into effect.

If the plan has a discretionary formula, the company does not need to adopt a formal amendment to the plan. Matching contributions that have been allocated to participant accounts cannot be returned to the employer.

Special considerations for safe harbor plans

In recent years, many companies have adopted "safe harbor" designs for their 401(k) plan so that the plan will automatically pass non-discrimination and top-heavy testing requirements. A safe harbor design requires the company to make either a minimum matching contribution on employee elective deferrals or a 3% employer contribution for all eligible employees, whether they make elective deferrals or not.

The IRS permits the suspension or reduction of safe harbor contributions mid-year if certain requirements are met:

First, the annual safe harbor notice provided to eligible employees before the beginning of the plan year must include a statement that the plan could be amended during the plan year to reduce or suspend safe harbor contributions. Most safe harbor notices include this statement, but the company should review its notice to confirm. If the statement is not included in the annual notice, the company may not suspend or reduce safe harbor contributions unless it can show that it is operating at an economic loss.

Second, the company must provide a supplemental notice to plan participants at least 30 days before the suspension or reduction goes into effect. The notice must explain how and when the plan will be amended and inform participants that they have the option to change their deferral elections before the safe harbor contributions are suspended or reduced.

Third, the plan must be amended not only to suspend or reduce the safe harbor contribution, but also to add nondiscrimination testing provisions for the plan year.

And finally, non-discrimination testing must be conducted for the plan year, using the current test-year method.

Notifying employees

Oddly, there is no legal requirement to notify plan participants before the suspension or reduction goes into effect unless the plan is a 401(k) safe harbor plan or a money purchase plan. However, for employee relations as well as compliance with ERISA fiduciary duty purposes, the company should always notify plan participants in advance of a material change in their retirement benefit formula.

A money purchase plan is classified as a pension plan subject to a notice requirement under Section 204(h) of ERISA. A 204(h) Notice is must be given in advance of the effective date of an amendment to reduce or eliminate contributions. If the plan has 100 or more participants, the notice must be given at least 45 days in advance. Smaller plans need to give 15 days' advance notice.

If the plan needs to be amended, a "Summary of Material Modification" to the Summary Plan Description must be distributed to the plan participants within 60 days after the effective date of the amendment.

Other considerations

The suspension or reduction could have a significant effect on nondiscrimination test results for 401(k) plans. The company should ask its 401(k) recordkeeper to run sample tests mid-year.

If the sample tests indicate an increase in the number of contribution refunds or forfeitures for highly compensated employees, the company should inform the affected employees so that they can adjust their elective deferral contributions to minimize or avoid taxable refunds next year.

Keep good records

The importance of keeping good records for all 401(k) plan decisions cannot be overstated. A plan amendment needs to be approved by the persons identified in the plan document as the persons with authority to do so. Usually, this will be the Board of Directors or a committee appointed by the Board. The approval should be in the form of resolutions, with recitals that explain the purpose of the amendment. The amendment should be filed in the minute book with the resolutions. Copies of all participant notices should be retained with plan records for at least 6 years, and preferably until 3 years after the plan is terminated.

And as with so many decisions, follow-through is everything. It is mind-boggling how often plan sponsors neglect to actually sign and date a plan amendment.  If an IRS or DOL auditor comes knocking on your door, signed plan documents and board resolutions approving the documents will be on the top of the auditor's document request list.

Failing to sign a plan amendment makes the amendment void and will jeopardize the tax-qualified status of the plan.  Moreover, the company exposes itself to allegations of a fiduciary breach or engaging in a prohibited transaction if it suspends contributions when the plan was not formally amended. Marie D. Carter is of counsel at Hirschler in Richmond, VA.  She counsels public, private, governmental and tax-exempt entities on a range of legal issues related to tax-qualified retirement plans, health and welfare plans, annual and long-term incentive programs and executive compensation arrangements. She may be reached at [email protected].