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Key Considerations for Suspending Employer 401(k) and 403(b) Contributions

Joshua P. Itzoe, CFP®, AIF®

In these unprecedented and uncertain economic times, many plan sponsors are looking at ways to conserve cash and control spending. Options for consideration include applying for government loans through the CARES Act and other programs, reducing employee compensation, implementing furloughs, and, as a worst-case scenario, making layoffs.

If business cash flow is significantly disrupted, one strategy some plan sponsors may consider is a suspension, reduction, or delay of employer contributions to its retirement plan. The options available to plan sponsors depend on whether a plan uses a safe harbor design and what type of contributions are provided (discretionary versus non-elective).

Non-Safe Harbor Plans – Suspension or Reduction
Non-safe harbor plans have the most flexibility and are the easiest to change. The steps involved depend on whether the plan makes discretionary or nonelective contributions (e.g., a fixed match).

Discretionary contributions
These can be suspended at any time and do not require a plan amendment. Plan sponsors can simply decide not to contribute for the year and there are no notification requirements for participants. However, it is our strong recommendation that plan sponsors who are considering this option provide detailed communication outlining the rationale for the changes and provide the effective date for when these changes are to take place. Doing so will allow your participants to plan for the changes accordingly. Being transparent with employees is an excellent policy, and one that we believe is a best practice for plan sponsors. Discretionary contributions can also resume in the future without re-amending the plan.

Fixed or Nonelective Contribution
Plans with a fixed contribution, like a match or stated percentage of salary, must be formally amended to remove the provisions outlining the contribution formula. The plan sponsor should pass a resolution to suspend or reduce contributions, notify the participants and adopt an amendment changing the contribution formula. These contributions must also be made to the plan on a pro-rated basis for the year, up to the effective date of the amendment, as long as the participant meets the allocation conditions.

Safe Harbor Plans – Suspension or Reduction
Generally, safe harbor contributions cannot be suspended or reduced mid-year, but there are two exceptions. To qualify, plan sponsors must meet one of the following conditions:

  1. The safe harbor notice provided to employees specified the right to suspend or reduce contributions during the year.
  2. The plan sponsor is suffering a business hardship as defined in Section 412(c) of the tax code.

Like non-safe harbor plans with a fixed contribution, IRS rules require that safe harbor contributions (either match or nonelective) are made up to the effective date of the amendment. Participants must also receive a supplemental notice and given 30 days’ notice before the suspension or reduction becomes effective so they can change their elections. Also, non-discrimination testing must be done for the entire plan year, and not just the portion of the plan year during which the plan sponsor was not making safe harbor contributions.

Delaying Retirement Contributions
Some plan sponsors (that haven’t yet made their 2019 employer contributions) may decide not to suspend or reduce contributions but need some cash flow flexibility. A plan sponsor may delay making its 2019 contribution until later in the year if it wishes to do so but needs to be aware of the tax deductibility implications.

To deduct an employer contribution for a given year, it must be deposited by the due date (including extensions) of the company tax return. If the contribution is made after this date, the contribution needs to be deducted on the subsequent year’s return. For instance, assume a plan sponsor did not extend its company return and has a filing deadline of April 15, 2020, but it cannot fund its match contribution until August. In that case, the company would deduct the 2019 matching contribution on its 2020 return rather than for 2019.

One point of note, if the contribution is made before the filing due date (plus extensions), but AFTER the return is filed, the company would need to file an amended return to deduct the contribution amount.

Pitfalls to Avoid

The decision to suspend, reduce, or delay employer contributions is neither easy nor simple. If you find your business needs to consider these options, it is recommended that you seek legal counsel to provide guidance and work with your other plan service providers to determine what steps are needed to implement the changes.  Here are a few other considerations to keep in mind:

  1. Partial plan termination – A partial plan termination is based on facts and circumstances but generally defined by the IRS as an involuntary termination of over 20% of plan participants. Plan sponsors that are laying off employees need to be aware of this rule because this event triggers 100% vesting for any impacted participant.
  2. Implications for nondiscrimination and top-heavy testing – Suspending or reducing employer contributions can negatively impact testing, specifically, the Actual Contribution Percentage (ACP) test which includes matching, increasing the likelihood of a failed test that requires correction through additional contributions to NHCEs or refunds for HCEs. Also, a failed top-heavy test will generally require a minimum contribution of 3% to “non-key employees”.
  3. Long-term impact on your workforce – Drastic times call for drastic measures and plan sponsors may have no other choice. But suspending or reducing retirement contributions should be a last resort since these monies have a compounding effect and significant long-term financial impact for employees.

If you have questions about this topic or any others that relate to your corporate retirement plan, please reach out to me directly.