Economic disruption in the first two quarters of 2020, combined with future business uncertainty about the COVID-19 pandemic, is prompting Employee Retirement Income Security Act (ERISA) retirement plan sponsors to review their pension plan management options.
Industry sectors that have been particularly hard-hit by COVID include retail, hospitality, health care, transportation, commercial real estate, and state and local governments. While the unemployment rate has recovered substantially, millions of workers remain unemployed. Employers are responding to the demands of the rapidly changing operating environment in a number of ways.
This article will address how ERISA retirement plan sponsors might react to maintain compliance and fiduciary obligations while protecting the future security of plan assets. Next month we will examine how retirement plan participants are responding to the pandemic.
COVID Considerations for ERISA Retirement Plan Sponsors
The pension fund industry is likely to see changes if behavioral economics influence the economic decision-making processes of retirement plan sponsors.
The impact of COVID on an ERISA retirement plan will depend on the type of plan involved and the requirements set forth in the Summary Plan Description (SPD) as well as related plan documents. The manager of a defined contribution plan typically has more flexibility than the sponsor of a defined benefit plan, for example.
All actions taken by a retirement plan sponsor must be evaluated in regard to fiduciary liability regulations. Potential cost reduction efforts may include the following:
• Reduce or suspend discretionary employer contributions in a retirement profit-sharing plan. There is no set amount of contribution required by law, and a plan amendment is not required for a plan sponsor to change the amount of its annual contribution. If there is an employer contribution, plan documents determine how it will be distributed.
• Reduce or suspend safe harbor contributions to a 401(k) plan. Notification requirements for these rules were changed recently under the Setting Every Community Up for Retirement Enhancement Act (SECURE Act).
• Reduce or suspend the match that an employer contributes to a plan participant’s account, up to a certain percentage. This action generally requires an amendment to the plan documents, making it a less attractive option. According to a June 2020 Willis Towers Watson survey, 15 percent of employers surveyed said they suspended or reduced their match and another 10% said they are considering action.
• Transfer pension obligations to third parties (typically life insurance companies) who assume responsibility for payment and administration of future pension payments to plan participants and their beneficiaries. We wrote about trends in this “de-risking” strategy in a December 2019 article titled, “Pension Risk Transfer Review for 2019.”
• Close a plan to new participants but continue to accrue benefits for existing participants. This is often referred to as a “soft” freeze.
• Monitor the management of plan distributions. The payment of a coronavirus-related distribution to a qualified individual must be reported by the eligible retirement plan on Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
• Manage the tracking and reporting of COVID-19 layoffs and rehires in a business’s qualified retirement plan.
Background on ERISA Defined Benefit Plans versus Defined Contribution Plans
A “defined benefit plan” means that an employer is obligated to provide plan participants a pre-defined benefit level. The amount of payment could be either a fixed dollar amount payment at retirement (i.e., $100 per month), or a percentage of salary determined in part by the number of years employed. Regardless of the method used to calculate benefits, the sponsor of a defined benefit plan has limited flexibility in modifying benefit levels.
A “defined contribution plan” does not include the promise of a specific benefit payment at retirement. A 401(k) plan, profit sharing plan, or employee stock ownership plan are the most common examples of defined contribution plans. Plan participants are completely vested in their own contributions (including any investment gains, losses or fees) and become vested in any contributions that may be made by the plan sponsor based on the terms of the plan.