word collage using cost cutting and synonyms to form shape of scissors (Photo: Shutterstock)

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Companies looking for ways to reduce their expenses and improvecash flow during the COVID-19 pandemic are asking whether it ispermissible to suspend or reduce contributions to their definedcontribution retirement plan. As usual, the answer is "itdepends."

Suspending profit sharing & money purchase plancontributions

Profit-sharing plans or money purchase plans that promise thecompany will make a stated contribution amount each year, such as5% of compensation, can be amended mid-year to change thecontribution formula. The amendment can always be appliedprospectively with respect to compensation earned after theeffective date. For example, if the amendment is effective August1, 2020, participants would be entitled to an allocation of 5% ofcompensation earned through July 31, and 0% for compensation earnedafter July 31.

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Many of these plans require that the employee must be employedon the last day of the plan year to be entitled to thecontribution. A plan with this "last day" rule could be amendedretroactively to the first day of the plan year because no one willaccrue the right to the contribution until the last day.

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Similarly, many plans require that an employee must complete1000 hours of service during the plan year to earn the right to thecontribution. The plan could be amended retroactively for anyemployee who has not met the service requirement as of theeffective date of the amendment.

Suspending 401(k) matching contributions

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

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If the plan has a fixed formula, the plan document will need tobe amended before the match suspension or reduction can go intoeffect.

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If the plan has a discretionary formula, the company does notneed to adopt a formal amendment to the plan. Matchingcontributions that have been allocated to participant accountscannot 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 automaticallypass non-discrimination and top-heavy testing requirements. A safeharbor design requires the company to make either a minimummatching contribution on employee elective deferrals or a 3%employer contribution for all eligible employees, whether they makeelective deferrals or not.

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

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First, the annual safe harbor notice provided to eligibleemployees before the beginning of the plan year must include astatement that the plan could be amended during the plan year toreduce or suspend safe harbor contributions. Most safe harbornotices include this statement, but the company should review itsnotice to confirm. If the statement is not included in the annualnotice, the company may not suspend or reduce safe harborcontributions unless it can show that it is operating at aneconomic loss.

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Second, the company must provide a supplemental notice to planparticipants at least 30 days before the suspension or reductiongoes into effect. The notice must explain how and when the planwill be amended and inform participants that they have the optionto change their deferral elections before the safe harborcontributions are suspended or reduced.

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

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

Notifying employees

Oddly, there is no legal requirement to notify plan participantsbefore the suspension or reduction goes into effect unless the planis a 401(k) safe harbor plan or a money purchase plan. However, foremployee relations as well as compliance with ERISA fiduciary dutypurposes, the company should always notify plan participants inadvance of a material change in their retirement benefitformula.

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

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

Other considerations

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

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If the sample tests indicate an increase in the number ofcontribution refunds or forfeitures for highly compensatedemployees, the company should inform the affected employees so thatthey can adjust their elective deferral contributions to minimizeor avoid taxable refunds next year.

Keep good records

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

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And as with so many decisions, follow-through is everything. Itis mind-boggling how often plan sponsors neglect to actually signand date a plan amendment.  If an IRS or DOL auditor comesknocking on your door, signed plan documents and board resolutionsapproving the documents will be on the top of the auditor'sdocument request list.

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Failing to sign a plan amendment makes the amendment void andwill jeopardize the tax-qualified status of the plan. Moreover, the company exposes itself to allegations of a fiduciarybreach or engaging in a prohibited transaction if it suspendscontributions when the plan was not formally amended.Marie D. Carter isof counsel at Hirschler in Richmond, VA.  She counselspublic, private, governmental and tax-exempt entities on a range oflegal issues related to tax-qualified retirement plans, health andwelfare plans, annual and long-term incentive programs andexecutive compensation arrangements. She may be reached at [email protected].

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