The economic disruption in the first two quarters of 2020, combined with future business uncertainty over the COVID-19 pandemic, is driving the Employee Retirement Income Security Act (ERISA) sponsors of retirement plans to review your pension plan management options.
Industry sectors that have been particularly affected by COVID include retail, hospitality, healthcare, transportation, commercial real estate, and state and local governments. Although 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 discuss 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 undergo changes if behavioral economics influences 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 administrator of a defined contribution plan generally has more flexibility than the sponsor of a defined benefit plan, for example.
All actions taken by the sponsor of a retirement plan must be evaluated against fiduciary liability regulations. Potential cost reduction efforts may include the following:
• Reduce or suspend employer discretionary contributions in a retirement profit sharing plan. The law does not require a fixed contribution amount and a plan amendment is not required for the plan sponsor to change the amount of your annual contribution. If there is an employer contribution, the plan documents determine how it will be distributed.
• Reduce or suspend safe harbor contributions to a 401 (k) plan. The notification requirements for these rules were recently changed under the All Communities Configuration for Retirement Enhancement Act (SECURE Act).
• Reduce or suspend the contribution an employer makes 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 contribution and another 10% said they are considering taking action.
• Transferring pension obligations to third parties (generally life insurance companies) who assume responsibility for the payment and administration of future pension payments to plan participants and their beneficiaries. We wrote about the trends in this “risk elimination” strategy in a December 2019 article titled “Pension Risk Transfer Review for 2019.”
• Close a plan for new participants but continue to increase benefits for existing participants. This is often called “soft” freezing.
• Monitor the management of plan distributions. Payment of a coronavirus-related distribution to a qualifying person must be reported by the eligible retirement plan on Form 1099-R, Pension Distributions, Annuities, Retirement or Profit Sharing Plans, IRAs, Insurance Contracts, etc.
• Manage the monitoring and notification of COVID-19 layoffs and rehires in a company’s qualified retirement plan.
Background to ERISA Defined Benefit Plans Versus Defined Contribution Plans
A “defined benefit plan” means that an employer is required to provide plan participants with a predefined level of benefits. The amount of the payment could be a fixed dollar amount at retirement (that is, $ 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 to change benefit levels.
A “defined contribution plan” does not include the promise of a specific benefit payment upon 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 fully vested with their own contributions (including profit, loss, or investment fees) and are vested in any contributions that the plan sponsor may make under the terms of the plan.