October 11, 2022

Benefit Plan Considerations for Employers in a Market Downturn

When markets are unpredictable, employers may be required to make business decisions that can have unanticipated effects on their retirement and health and welfare benefit plans. Employers should keep the following considerations in mind to ensure they comply with their benefit plan obligations.

Benefits Continuation during Layoffs, Furloughs and other Leaves of Absences

Employers looking to control costs by reducing headcount should be aware that implementing a “layoff” can have a different impact on their benefit plans than implementing a “furlough.” This is because a “layoff” generally means a termination of employment (and subsequently a termination of benefit plan participation), while a “furlough” generally means that an employee is in unpaid, non-active status where no duties are performed, often with an expectation that he or she will return to employment at some future date. 

Because, for employees on furlough, the employment relationship remains intact, it is possible that they can continue to participate in their employer’s benefit plans if the terms of the plan so provide. For example, in the health and welfare benefit context, plan documents and insurance contracts often define eligibility for coverage by “active” employee status (typically based on the number of hours per week worked). Employers should review the terms of their plans and insurance contracts to determine whether furloughed, non-active employees remain eligible for benefits. If not, employers may find themselves responsible for providing benefits (either the cost of coverage or perhaps the cost of actual claims) if they have promised coverage to furloughed employees that the insurer has not agreed to provide. Employers that maintain self-insured plans should review their contract terms with any stop-loss insurer for the same reason. If a plan does not currently cover furloughed employees but the employer and insurer agree to do so, both the written insurance contract and the plan documents will need to be amended.

Employees affected by a layoff, furlough, or reduction in force may be eligible for COBRA coverage to continue their health benefits. To be eligible for federal COBRA coverage*, an employee must experience both a triggering event and a loss in coverage. A triggering event includes not only a termination of employment but also a reduction in hours, but such event must also result in a loss in coverage within the typical COBRA 18-month maximum coverage period. The timing of COBRA election notices, the commencement of the maximum coverage period, and the impact of Affordable Care Act requirements are complex issues that employers should discuss with their COBRA service provider(s) and/or counsel.

*Note: employers with under 20 employees must be aware of state “mini-COBRA” laws; certain states also provide continuation rights that supplement federal COBRA.

Employer Contribution Holidays for Defined Contribution Retirement Plans

Employers looking to control costs can also consider temporarily suspending, or even eliminating, company matching or profit sharing contributions to defined contribution retirement plans (e.g., 401(k) plans). (Please note that different rules apply to defined benefit pension plans and multiemployer plans, which are beyond the scope of this alert.) An employer’s ability to make this change depends on its plan design. For example, employers that sponsor safe harbor 401(k) plans must make annual contributions to be exempt from certain nondiscrimination testing requirements. Applicable regulations generally provide that plan sponsors of safe harbor plans can suspend these contributions only if the employer is operating at an economic loss, or if the annual safe harbor notice provides that the employer can suspend such contributions. If so, plan sponsors must issue a notice describing the change 30 days before the effective date of the change. A mid-year suspension will also require the plan sponsor to conduct certain nondiscrimination tests for the plan year in which the change occurs.

Plan sponsors of non-safe harbor plans have more flexibility when implementing changes to their employer contribution provisions. If the employer contribution is purely discretionary (for example, if the plan sponsor simply declares its contribution, if any, at the end of each plan year) then a plan amendment may not be required. Otherwise, employer contributions may be adjusted prospectively via plan amendment. Note, however, that ERISA and the Internal Revenue Code contain strict provisions regarding the elimination or cutback of benefits that may have accrued to participants. It is important to consult with legal counsel prior to making any employer contribution changes, as additional considerations may apply regarding impermissible cutbacks and mid-year vested benefits.

Loans and Hardship Distributions

It is not only employers who may be looking for ways to mitigate against financial uncertainty or cover additional unanticipated costs. Retirement plan participants may also be interested in accessing additional financial resources. Participants may want to take plan loans or may need to take hardship distributions, and plan sponsors should anticipate whether changes may be needed to facilitate that. For example, plan sponsors may wish to increase participants’ loan limits or expand permissible hardship distribution options. Changes will generally require plan amendments and changes to other plan-related documents (such as a summary plan description or plan loan procedures), and typically can be implemented only on a prospective basis. That means that plan sponsors of calendar year defined contribution plans should determine in the 2022 whether any changes will be implemented for the 2023 plan year. 

Partial and Whole Plan Terminations

Large-scale reductions in force may have unintended consequences for an employer’s retirement plan. Generally, a “partial plan termination” occurs when more than 20% of a plan’s participants have an employer-initiated severance from employment, even if the involuntary termination of employment is caused by reasons beyond the employer’s control (such as an economic downturn). An employer-initiated severance from employment is generally any involuntary termination of employment other than death, disability or retirement on or after normal retirement age. Upon a partial plan termination, affected participants must be fully vested in all amounts credited to their accounts, and in all benefits accrued up to the date of the partial termination. It is important to note that, for this purpose, “affected participants” include all participating employees who had a severance from employment during the applicable period, even if they voluntarily terminated employment. The “applicable period” is typically one plan year, although it can be longer if there is a series of related severances from employment. For short plan years, the “applicable period” includes the short plan year and the preceding plan year. Employers should work with their legal counsel and other advisers to determine whether their retirement plans have had a partial plan termination, and if so, which participants require an acceleration of vesting. 

Some employers may find themselves wanting to terminate their retirement plans for all participants. A plan is considered to be fully terminated only if the plan sponsor sets a specific date for termination, determines plan benefits and liabilities as of that date and distributes all plan assets as soon as administratively feasible (generally within 12 months of the termination date). All participants must also be 100% vested in their accounts as of plan termination. Employers should designate a responsible plan fiduciary who can manage the termination process, including potentially filing for a final determination letter, preparing the final Form 5500, working with the recordkeeper to distribute assets, and managing (and ultimately terminating) plan service providers throughout the termination process. Also note that this is a general description of plan termination considerations and that special issues arise if an employer is considering terminating a defined benefit pension plan (rather than a defined contribution plan, such as a 401(k) plan).

Investment and Plan Fiduciary Considerations

In light of ongoing market volatility, plan fiduciaries should review plan investments and investment policies on a consistent, periodic basis. Decisions should be documented (for example, in meeting minutes of the plan’s investment committee), and should be consistent with the plan’s investment policy statement and applicable procedures. Plan fiduciaries should also work with their plan investment advisors to determine whether any changes to the plan’s investment line-up or investment policy are advisable. 

Contact Goodwin ERISA + Executive Compensation team members Natascha George, Rachel Faye Smith or Melissa Sandak for any questions related to the impact of economic changes and workforce reductions on your compensation and benefits arrangements