The uncertainties surrounding the COVID-19 pandemic have made it difficult for employers to predict the long-term impact of the pandemic on their businesses. In response, many employers are looking for ways to preserve cash reserves by reducing or deferring benefit and compensation costs, without taking the more drastic step of permanently reducing their workforces. We have summarized below some of the near term cash preservation measures that employers might consider with respect to their benefit and compensation arrangements.
Each of the measures described below requires that employers take a number of factors into consideration, including the potential impact on employee relations. In addition, making material changes to benefit and compensation arrangements requires providing timely, and in some cases advance, notice to employees of the changes being made. How such changes get communicated to employees, including an explanation of the economic challenges that have made the changes necessary, can go a long way towards achieving employee understanding and support.
Defined Contribution Retirement Plans
- Reduce Employer Contributions. A plan can be designed to provide for employer contributions based on a fixed or discretionary formula. For employer contributions based on a discretionary formula, employers may exercise their discretion to prospectively reduce the amount of such contributions. For employer contributions based on a fixed formula, employers may also be able to amend their plans to reduce the amount of such contributions.
- Delay Timing of Employer Contributions. With respect to fixed employer contributions that are scheduled to be made upon each payroll period, employers may be able to amend their plans to delay the timing of employer contributions until after the end of the plan year.
- Change Allocation of Employer Contributions. A plan can be designed to impose different eligibility conditions on different types of contributions. As such, an employee eligible to make elective deferral contributions can be required to meet higher service requirements to be eligible for employer contributions. For example, employers may be able to amend their plans to condition receipt of employer contributions on employees’ being credited with a year of service during the plan year and/or being employed on the last day of the plan year.
- Eliminate Safe Harbor Employer Contributions. To avoid having to satisfy nondiscrimination testing, a plan may be designed to require that the employer make a safe harbor amount of employer contributions. In order to eliminate this requirement, an employer must amend the plan to remove provisions requiring safe harbor employer contributions. Employers considering making this mid-year change should, however, review their plan’s related safe harbor notice to confirm that a mid-year change is permissible under the terms of the notice. Employers should also be aware that elimination of safe harbor contributions will require the plan to satisfy nondiscrimination testing.
- Use Plan Forfeitures for Plan Expenses. Defined contribution retirement plans are typically designed to provide that participants who fail to satisfy applicable vesting requirements forfeit the employer contributions made on their behalf. Plans can be further designed to allocate such forfeited amounts in a number of ways, including to pay permissible plan expenses. Employers might, therefore, consider amending their plans to allow for the use of forfeitures to pay for plan expenses if the plan does not already provide so.
Defined Benefit Retirement Plans
- Delay Minimum Required Contributions. A minimum required contribution is the minimum amount that an employer must contribute to a defined benefit retirement plan to meet minimum funding requirements for an applicable plan year. Pursuant to the CARES Act, single employer defined benefit retirement plans are permitted to delay minimum required contributions, including quarterly contributions, otherwise due in 2020 until January 1, 2021.
- Request Waiver of Minimum Funding Requirement. An employer that is unable to meet minimum funding requirements for the 2020 plan year may request permission from the IRS to satisfy such minimum funding requirements over a longer period of time. Funding waiver applications are complicated and require extended negotiation with the IRS, as well as providing notice to the PBGC, plan participants and sometimes lenders.
- Make In-Kind Employer Contributions. Subject to satisfaction of strict fiduciary and statutory requirements, an employer can make minimum required contributions to a retirement plan in the form of property (e.g., securities and real property) instead of cash. Depending on the specific property used for in-kind employer contributions, an employer may be required to seek DOL approval before making the contribution.
- Delay PBGC Premium Payments. Most defined benefit retirement plans are required to pay premium payments to the PBGC for insuring the plan. Pursuant to PBGC-issued disaster relief, PBGC premium payments otherwise due on or after April 1, 2020 through July 14, 2020 may be delayed until July 15, 2020. A plan delaying payments pursuant to this relief must notify the PBGC of the plan’s eligibility before July 15, 2020.
- Terminate Fully Funded Plan. Employers who sponsor a fully funded defined benefit retirement plan may be able to terminate the plan to eliminate the obligation to continue making PBGC premium payments and recoup any excess funding. Termination of an underfunded defined benefit retirement plan would result in a similar savings with respect to the cessation of PBGC premium payments, but would also accelerate the sponsoring employer’s obligation to make up for any funding shortfall.
Other Benefit Arrangements
- Reduce Fringe Benefits. During the recent economic expansion that has now stalled, employers facing a tightening labor pool began increasing and expanding their fringe benefit offerings to improve employee retention. Employers might now consider reducing or eliminating fringe benefit offerings unrelated to healthcare, such as leave sharing and tuition reimbursement programs.
- Tap Wellness Funds. Some group health plan insurance contracts and third-party administrator agreements provide for employer contributions towards wellness initiatives. Employers should review such arrangements to determine whether wellness funding can instead be allocated towards the employer portion of the cost of coverage. We note, however, that eliminating wellness initiatives now may increase costs long-term by adversely impacting medical care utilization rates for preventable illnesses and injuries.
- Audit Dependent Eligibility. Group health plans typically provide coverage to employees and employee dependents only if they satisfy specified eligibility requirements. Over time, employees’ dependents may cease satisfying such eligibility requirements because of changes in status, such as aging out of the plan or experiencing a divorce, without notifying the plan of the change. Employers with self-funded group health plans in particular may want to audit the eligibility of participating dependents to confirm that such participants are in fact still eligible for coverage.
- Deny Early Nonqualified Distribution Requests. Distributions from a nonqualified deferred compensation plan are paid from the sponsoring employer’s general assets, subject to Section 409A rules that generally prohibit making distributions too soon. Plan participants may, however, be eligible for earlier distributions based on an unforeseeable emergency. A sponsoring employer that receives an early distribution request from a participant based on an unforeseeable emergency is permitted under Section 409A rules to exercise its own discretion to deny the request, subject to the terms of the plan.
- Reduce Compensation. This is one of the more obvious cash preservation measures, but we include it here to note that employee and/or union consent may be required prior to implementing wage and salary reductions if the terms of employment are governed by an employment agreement or collective bargaining agreement. Thus far, employers making such cuts have frequently done so on a broad and progressive basis, with the largest cuts applied to the most highly compensated employees.
- Pay Compensation in Stock. Employers can reduce the current cash cost of compensation arrangements by making certain compensation payments in the form of equity. For example, employers may be able to pay compensation obligations or settle outstanding equity-based awards in stock instead of cash. We note that, depending on the terms governing the compensation or outstanding awards, settling compensation or awards in stock may require employee consent. In addition, paying compensation with stock will increase shareholder dilution and may reduce the amount of stock available in reserves for future award grants.
Most of the cash preservation measures described above require employers to satisfy statutory, regulatory and/or contractual requirements prior to implementation. If you would like to discuss any of the options described above or have any questions about how to make changes to your existing employee benefit and compensation arrangements, please contact a member of our Employee Benefits Group.