During times of economic uncertainty, like the COVID-19 situation that we’re currently in, many companies look for ways to reduce expenses to help keep employees on payroll. One of the expenses you may be considering reducing or eliminating is your company’s matching contribution to the retirement plan.
This is usually an effective measure that can help companies avoid financial ruin, but there are some side-effects to eliminating certain types of matching contributions that can result in unexpected costs.
This is why you will need to lean on experienced plan administration experts to help you navigate some of the complex issues involved with stopping employer contributions. We’ll cover some of the issues in this article.
Non-Safe Harbor Plans
If your company’s retirement plan is using a discretionary match, you can generally reduce or eliminate these employer contributions mid-year fairly easily without the need for a plan amendment. Even though there is not an employee notice requirement to stop this type of match, you would still want to provide your employees with ample notice (typically 30 days) to preserve company morale.
So, what is a discretionary match? A discretionary match is one that does not have a defined formula stated in your plan document. Your document may say something about the employer having the discretion to make additional matching contributions, but it would not state the match formula.
If you’re using a “fixed” matching contribution formula that’s defined in your plan document (ie. 100% up to 3% of pay), eliminating the match will require a plan amendment and an employee notice called a Summary of Material Modifications (SMM). The SMM’s delivery timing requirement is much later than one might expect, but you will probably want to provide the SMM in advance of the change so that employees have an opportunity to make adjustments to their deferral rates before the changes are effective.
When you’re making an amendment to your plan, the SMM must be provided no later than 210 days after the close of the plan year for which the modification was adopted. This guidance can be found directly on the IRS website.
Compliance Issues for Non-Safe Harbor Plans
When a plan is top heavy, there’s a minimum contribution that’s required to all eligible employees if any of your Key employees are benefiting under the plan. And previously, your matching contributions were offsetting this minimum requirement dollar for dollar. But when that matching contribution is no longer in place to offset some of the top heavy requirements, you could end up having to make a large top heavy minimum contribution at the end of the year. So, stopping your match may result in only delaying costs instead of avoiding them altogether.
The top heavy minimum contribution can vary, but In some cases it can be as high as 3% of compensation for all eligible employees, even those that are not participating in the plan – which can add up quickly.
What is “Top Heavy”?
When a plan is “Top Heavy”, it means that the aggregate value of your Key employees’ (certain officers & certain owners that meet the “Key” definition) plan assets are greater than 60% of total plan assets on the last day of the latest plan year.
What is a “Key Employee”?
A Key Employee is an employee that meets any of the following three conditions:
- a more than 5% owner of the plan sponsor or a related employer; also any lineal descendent of a more than 5% owner
- an individual who owns more than 1% of the plan sponsor or a related employer AND has annual compensation exceeding $150,000
- an officer of the plan sponsor or a related employer with annual compensation exceeding $185,000 (this number is indexed each year), limited to 10% of the total number of employees
If your matching contribution is using an annual allocation period but you were remitting contributions each pay period, you may need to do a true-up through the effective date of your match’s elimination to account for the variation between the actual match received versus your plan’s actual match formula. This is especially true if your plan document states that the match formula is required to be uniform across all participants. However if your plan does not require the match to be uniform, then a true-up may not be due but it would have to pass non-discrimination testing.
Deposit Timing Requirements
Non-safe harbor matching contributions have more flexibility than their safe harbor counterparts. The general deadline for depositing matching contributions to the plan is the due date of the company’s tax return for deductibility purposes, or 30 days after the company’s tax filing due date for Annual Additions purposes.
Safe Harbor Plans
If your plan is safe harbor (meaning you have a Safe Harbor Match or a Safe Harbor Non-Elective), there are more things to consider when weighing the option to eliminate your employer contribution.
Are You Eligible to Eliminate Your Safe Harbor Contribution?
To eliminate your Safe Harbor contribution, you must satisfy one of the two following prerequisite conditions:
- Your Annual Notice must have included “Maybe Not” language; or…
- Your company must be operating at an economic loss as defined in IRC Section 412(c)(2)(A)
These rules don’t apply if your plan is terminating or shutting down completely. There’s a separate set of rules that apply to Safe Harbor plans that are in the termination process.
Required Actions for Safe Harbor Plans
If you satisfy either of these conditions, then you’re eligible to go through the rest of the steps to eliminate your Safe Harbor contribution.
- You must amend the plan
- You must provide employees a supplemental notice at least 30 days in advance of the match elimination or reduction effective date
What’s the impact of stopping my safe harbor contribution?
Stopping safe harbor contributions can make a big impact on your plan’s annual compliance testing because many of these tests were deemed to be automatically satisfied by your safe harbor contributions. But now that those contributions are stopped, your plan will lose reliance on the automatic pass and will now be subject to the tests.
Most compliance test deal with non-discrimination, which focuses on comparing benefits accumulated by your highly-paid employees and company owners versus your non-owner and non-highly paid employees.
Compliance Issues for Safe Harbor Plans
If you eliminate or reduce your Safe Harbor contributions mid-year, you will lose reliance on your plan’s Safe Harbor exemption from the ADP/ACP non-discrimination tests and exemption from satisfying Top Heavy rules.
ADP/ACP Test Considerations for Safe Harbor Plans
By eliminating your Safe Harbor contribution, your plan will now need to satisfy the ADP and ACP test for the entire plan year. This means that the full year compensation and contribution values are used when performing the tests.
Worst case scenario, you fail the tests and have to take corrective measures in the form of either corrective distributions from your Highly Compensated Employees (HCEs) or corrective contributions to your Non-Highly Compensated Employees (NHCEs).
Check out our other article on ADP/ACP test corrections for more details.
Top Heavy Rules and Safe Harbor Plans
Top heavy rules are where substantial unexpected costs can come into play for safe harbor plans. If your plan is top heavy for the year in which you’re eliminating a Safe Harbor contribution, you should compare the cost of keeping your match against the potential cost associated with satisfying the top heavy minimum requirements. Often times, it will be less expensive to keep your match in place than to pay the top heavy minimum.
When a plan is top heavy, there’s a minimum contribution that’s required to all eligible employees if any of your Key employees are benefiting under the plan. And previously, your Safe Harbor contributions were automatically deemed to satisfy that minimum contribution requirement. But when that Safe Harbor contribution is no longer in place, you now how have meet that top heavy minimum requirement for all eligible non-key employees – even those who are not participating.
The top heavy minimum can vary, but In some cases it can be as high as 3% of compensation for all eligible employees – which can add up really quickly and may far exceed what you were paying for matching contributions.
Safe Harbor Funding Timing Requirements
Some plans state that their safe harbor matching contributions will be made annually at the end of each plan year, while others state a more frequent allocation period (per pay period, monthly, etc.). There are different timing requirements for annual allocation plans versus all other allocation types.
Annual Allocation of Safe Harbor Match
If your company is taking a tax deduction for the safe harbor contributions, then the match is required to be remitted to the plan by the date you file your company’s tax return. However if you’re not concerned about deductibility, you have until the end of the following year to remit the contributions to the plan. So for example, 2020 safe harbor contributions are required to be remitted to the plan no later than 12/31/2021.
If you miss the tax return deadline, you can still take a deduction for safe harbor contributions on the next year’s tax return.
All Other Allocation Types
If your plan uses any allocation period other than plan year (per pay period, monthly, quarterly, etc.), safe harbor contributions are required to be remitted to the plan at least quarterly. This means safe harbor contributions accrued between January 1, 2020 and March 31, 2020 must be deposited to the plan by June 30, 2020.
Alternative Cost Reduction & Cash Flow Strategies
Safe Harbor vs Top Heavy Cost Comparison
Given some of the costs involved with satisfying Top Heavy rules, it can sometimes make sense to keep your safe harbor match in place instead of making a contribution that will satisfy the top heavy requirements. If your plan is top heavy, a cost comparison analysis will reveal which option would yield the lower cost.
Change the Definition of Compensation
Another way reduce your match cost is to modify your plan’s definition of compensation for matching calculation purposes. This means that certain types of compensation are not used in the matching formula. However, there are some additional compliance issues that can arise from this strategy. It’s best to use a definition of compensation that’s uniform across your entire workforce to avoid additional compliance testing under IRC Section 414(s).
Change Your Match Allocation Period to Annually
If steady cash flow is an issue, changing the match allocation from each pay period to annually can help defer cost until after the end of the plan year.
Use Allocation Conditions to Restrict Match Eligibility
Companies also use allocation conditions in their match formula to restrict which employees receive a match at the end of the year. A typical allocation condition set is that the employee must be employed on the last day of the plan year and must have worked at least 1,000 hours during the plan year. These conditions are only meant for annual allocation periods.
Reduce Your Match Formula
You can also reduce your match formula instead of eliminating it. Matching formulas that are stated in your plan document would require a plan amendment, but a discretionary match that’s not stated could be changed without a formal amendment.
These are just a few ideas of the ways you can reduce plan costs without having to fully eliminate your match. Each option has trade-offs that require careful consideration. So, you will want to work with an experience plan administrator who can help you identify the best option for your company’s situation.
Contact us if you have questions about the best strategy for your plan.