The novel coronavirus (COVID-19) has created great economic uncertainties for companies and their employees. This article provides timely information to assist non-qualified plan sponsors in answering the most common questions they may be receiving. These include:
- how participants may access their non-qualified plan accounts,
- whether deferrals may be suspended, and
- how to manage the plan in response to other human resources decisions including reductions in pay, changes to bonus programs, and temporary changes in an employee’s status with the employer.
As a preface, both qualified and non-qualified retirement programs are designed for long-term capital accumulation over 10 to 30 years and long-term payouts over periods that may extend for an additional 5 to 30 years. The purpose of these programs can be substantially undermined, if not lost, when participants access their accounts prior to the planned payment commencement date. In the case of requested withdrawals in current market conditions, participants will likely liquidate their accounts at significant losses, virtually ensuring that they will not participate significantly in a subsequent market recovery.
Unlike the economic downturn of 2008, which was driven in large part by structural weaknesses in the U.S. mortgage markets that cascaded through the financial system and took years to sort out, the current downturn is a conscious, concerted effort by the country to address a national and global health problem. Everyone is uncertain as to the duration of this particular downturn, but clearly many people are already suffering a cash crisis.
IRS Notice 2020-50 provides sponsors with the ability to cancel nonqualified plan deferrals for the remainder of 2020 for participants who have requested coronavirus-related distributions from their 401(k) accounts. The guidance provides relief in addition to the more restrictive unforeseeable emergency rules that permit cancellation of deferrals and distributions only in the event of a severe financial emergency.
Participants Accessing Non-Qualified Plan Accounts
With the relief provided under Notice 2020-50, there are now four ways to obtain limited amounts from a non-qualified plan:
1. unforeseeable emergency request under code section 409A
2. small balance cash out under the terms of the nonqualified plan
3. payments from pre-409A, “grandfathered” accounts
4. cancellation of nonqualified deferrals for the remainder of 2020 in connection with a coronavirus-related distribution from the participant’s 401(k) account.
Unforeseeable Emergency
An “unforeseeable emergency” may include the imminent foreclosure of or eviction from one’s primary residence. A reduction in pay, by itself, will generally not qualify as an unforeseeable emergency.
- The emergency is limited to each participant’s individual circumstance and must be determined case by case. Emergency measures taken by the employer, such as across-the-board pay reductions, could not assume that each participant will individually qualify for a distribution from the plan.
- The distribution is limited to the immediate need. The immediate need is the dollar value of the need after the participant’s other sources have been exhausted. Other resources include insurance and other non-essential personal assets. As described further below, the CARES Act and other relief may provide additional resources to participants impacted by the coronavirus.
Small Balance Cashout
A plan may provide or be amended to provide the employer with discretion to distribute a small balance to a participant at any time. The participant’s combined accounts under all other non-qualified plan maintained by the employer’s controlled group of organizations must not exceed $19,500 and the distribution must be a complete liquidation of the accounts. For this purpose, elective deferrals and company contributions (e.g., a matching account) are treated as separate plans, each having their own $19,500 limit. Elective deferrals that are expected to be made for the remainder of the year should be factored into the determination of the account balance (a plan could not, for example, cash out a balance today and then cash out the deferrals for each subsequent payroll if the combined plan deferrals at year-end would exceed $19,500).
Pre-409A, “Grandfathered” Accounts
Amounts deferred and vested under non-qualified arrangements on or before December 31, 2004 may continue to be paid under the terms of the pre-409A arrangement. Many of these arrangements provided for discretionary withdrawals, provided the participant’s account balance is reduced by a designated percentage of the withdrawal.
Pre-409A plans generally may be terminated and accounts paid without the need to terminate any of the employer’s plans that are subject to 409A.
Cancellation of Deferrals under IRS Notice 2020-50
Nonqualified plans may cancel a participant’s remaining deferrals for the year in the event of an unforeseeable emergency (discussed above) or in connection with a hardship withdrawal from the participant’s 401(k) account. The CARES Act provided 401(k) plan participants with the ability to withdraw up to $100,000 from their 401(k) accounts if the participant or the participant’s dependents were impacted in 2020 by the coronavirus. As enacted, the CARES Act withdrawal was not a hardship distribution, but a separate statutory authorization to make a pre-retirement distribution to impacted participants. IRS Notice 2020-50 provides that, with respect to nonqualified plans, CARES Act withdrawals are deemed to be hardship distributions and the sponsor of the plan may cancel participants’ deferrals as provided under the § 409A regulations.
Cancellation of nonqualified deferrals in connection with a 401(k) hardship distribution is one of a number of limited exceptions to § 409A’s “anti-acceleration rule” (the requirement that payments from a nonqualified deferred compensation plan cannot be made earlier than the agreed-upon payment date or payment event). In order to qualify for the exception, the sponsor must make the determination to pay without regard to the desires of individual participants. Similar to other permitted exceptions, such as payments to an alternate payee under a qualified domestic relations order, sponsors wishing to make early payments typically adopt uniform policies in order to demonstrate that the sponsor, and not the participant, is making the decision to make the early payment.
Plan Terminations
Non-qualified plans other than pre-409A “grandfathered” plans may be terminated only for business reasons and not with a purpose to accelerate payments from the plan. In order to separate “business driven” terminations from “acceleration driven” terminations, the 409A regulations require liquidating payments to be delayed a minimum of 12 months after the board of directors takes final action to terminate the plan. A distribution also will violate 409A if the board action to terminate occurs in connection with a “downturn” in the financial health of the employer. Because of the required delay in payment and the likely inability to terminate at all under current economic conditions, plan termination is not likely to be a viable source of funds for participants.
Suspending Deferrals
Some participants may want to suspend their deferrals to increase their existing take home cash flow. Generally, once deferrals commence for the calendar year, they may not be suspended. Exceptions include cancellation due to an unforeseeable emergency, disability or in connection with a CARES Act “hardship” withdrawal from a 401(k) plan. The conditions for a cancellation due to an unforeseeable emergency are the same as for taking a withdrawal, discussed above. If an unforeseeable emergency exists, deferrals will be cancelled for the remainder of the year.
A disability includes a medical condition that precludes the participant from performing his or her job functions. Note that this is not the same as a disability payment event from a non-qualified plan which is defined as the inability to perform any remunerative work for a period of at least 12 months or under conditions likely to result in the death of the participant.
Managing the Plan
Employers generally should continue to administer their plans as written, taking deferrals as elected and making plan payments as scheduled. The timing of the coronavirus’s arrival in the United States may require the following adjustments:
- Reductions in pay may cause some participants to fall below the plan’s guidelines for eligibility.
- Deferrals must continue for the remainder of 2020; Code Section 409A does not permit suspension due to the loss of eligibility mid-year.
- Deferrals of fixed dollar amounts must continue to be made. If annual compensation falls below the elected dollar amount, the participant’s deferrals will be limited to the amount earned.
• Mid-year bonus enrollments in 2020 may need to be adjusted or postponed.
- If performance metrics are adjusted after the first 90 days in the performance period, the bonus may no longer qualify as “performance-based” compensation and may not be deferred under the performance-based pay rules. If the performance-based pay rule is not available, other election timing rules may be available. Sponsors should consult their counsel for guidance as to whether the bonus continues to qualify as performance-based.
- Reductions in bonus potential generally would not affect an otherwise valid deferral election. A percentage deferral will apply the elected percentage to the lower bonus potential.
• Although a reduction in compensation subject to a deferral election generally will not constitute a change in the time and form of payment, a substitution of deferrable compensation source with a new source that is not deferrable under the terms of the plan could inadvertently result in an accelerated payment.
• Participants may be asked to forego compensation or take an unpaid furlough or leave of absence. A change in service level may raise questions as to whether a “separation from service” has occurred under the terms of the plan. Separation from service is based on the facts and circumstances and should be reviewed with counsel. In general, a separation from service occurs if the employee and employer anticipate that after a certain date the employee will no longer perform services for the employer or the level of services will be reduced permanently to 20% or less of the prior 36- month average. If the parties anticipate a return to service, a separation from service generally will not have occurred.
Legislative Relief
The CARES Act and IRS Notice 2020-50 allow participants in tax-qualified retirement plans such as 401(k) plans and governmental 457(b) arrangements to
- take hardship withdrawals up to $100,000 without a 10% penalty, and if provided under a uniform policy adopted by the sponsor, cancel deferrals into the participant’s nonqualified plan accounts for the remainder of 2020.
- spread the tax on the withdrawal from the tax-qualified plans over three years, and
- repay the withdrawal to the tax-qualified plans within three years, with the repayment treated the same as a tax-free rollover.
The CARES Act also permits loans from tax-qualified plans up to $100,000.
As noted above, retirement plans are designed for long-term capital accumulation, not short term needs. For sponsors this raises the issue as to the types of relief that will be made available and how they communicate the availability of emergency withdrawals and deferral cancellations from both qualified and non-qualified plans to their participants.
While Newport cannot provide personal financial advice, plan sponsors should be aware of the following non-plan resources which may provide more immediate relief while permitting participants to retain their retirement savings:
• Monthly payments on mortgages owned by Fannie Mae or Freddie Mac can be delayed up to 12 months without late fees for owners impacted by the coronavirus. Foreclosures will be suspended during this time and suspended payments will not be reported as delinquent to the credit agencies. See fhfa.gov for additional details. Homeowners may determine whether their mortgages are backed by the FHA at KnowYourOptions.com/loanlookup (Fannie Mae) and FreddieMac.com/mymortgage.
• Certain banks and other financial institutions have pledged mortgage relief in the form of suspended payments.
• Utilities and internet service providers may be offering similar programs or have stopped shutting off service for nonpayment.
• Employees who experience a layoff or unpaid furlough but expect to return to their jobs do not necessarily need to be terminated from employment in order to qualify for unemployment insurance. This varies by state. Insurance payments may be made over a period from 14 to 26 weeks. Under the CARES Act, unemployment insurance benefits provided by the state will be increased by $600 per week, up to four months as each participating state determines.
• The deadline for filing 2019 returns and paying federal income taxes is delayed to July 15 without penalties or interest and regardless of how much tax is owed. If a return has been filed, and taxes scheduled to be paid on April 15, the scheduled payment can be cancelled by calling 888-353-4537. The American Institute of Certified Public Accountants (AICPA) website lists the responses of each state to their respective filing and payment requirements.
It is likely that Congress and the federal agencies will continue to monitor relief efforts and provide further assistance in the near future. Newport will continue to monitor legislative and economic developments affecting plan sponsors and will continue to provide updates as they are made available. Newport teams are ready to meet with our clients and their advisors to assist in developing a comprehensive strategy to address the immediate needs of both sponsors and participants.
Read Newport’s perspective on market volatility here.
Newport Group, Inc. and its affiliates provide recordkeeping, plan administration, trust and custody, consulting, fiduciary consulting, insurance and brokerage services.
Newport Group and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal and accounting advisors before making any decisions.