Posted by Maria T. Hurd, CPA, RPA
In pandemic times, employer contributions to retirement plans are not immune to cost-cutting initiatives, as corporate cash flows and liquidity dwindle. However, discontinuing discretionary contributions does not always eliminate all employer contribution requirements, and it is important for employers to anticipate and budget for any contributions that cannot be eliminated.
Discretionary Profit Sharing, Nonelective, or Matching Contributions
Employers may have the misconception that the discontinuance of a discretionary profit sharing or matching contribution eliminates all employer contribution requirements, but that is not the case if the plan is top heavy.
The top-heavy rules generally ensure that non-key employees receive a minimum benefit if the plan is top-heavy. A plan is top-heavy when, as of the last day of the prior plan year, the total value of the plan accounts of key employees was more than 60% of the total value of the plan assets.
If the plan is top-heavy, the employer must contribute the lesser of:
- 3% of eligible employees’ annual compensation, or
- the highest contribution rate allocated to a key employee, including deferrals.
A top-heavy contribution must be credited to every non-key employee who is a participant in the plan and who is employed on the last day of the plan year. A top-heavy contribution may (but need not) be allocated to key employees’ accounts.
It is important not to confuse the top-heavy determination, based on participants’ account balances, with the annual testing that determines whether a year’s contributions are discriminatory in favor of highly-compensated employees.
A key employee is one who meets one of these three criteria:
- An officer making over $175,000 in 2018 or $180,000 in 2019 or $185,000 in 2020 (the income threshold is indexed by the IRS and may increase each year);
- Someone who owns more than 5% of the employer (family attribution rules apply); or
- An employee owning more than 1% of the business and making over $150,000 for the plan year.
At the end of each plan year, the top-heavy determination is made to establish whether the plan is top-heavy for the coming plan year. This allows plan sponsors to know in advance whether their plans will be top-heavy and take any appropriate actions rather than finding out after the fact.
If a discretionary profit sharing, nonelective, or matching contribution is discontinued as of January 1, but the key employees contribute a 401(k) or 403(b) elective deferral, the employer must still deposit a top heavy contribution. Similarly, if a safe-harbor plan, which is exempt from the top-heavy test, ceases to be a safe-harbor plan, the top-heavy exemption no longer applies for the plan year, and a top-heavy contribution may be owed.
Discontinuing a Safe-harbor Contribution
A safe-harbor matching contribution can be eliminated mid-year under only two circumstances. First, a plan sponsor can amend its safe-harbor plan to eliminate the safe-harbor matching or nonelective contribution if the employer is operating at an economic loss. In pandemic times, nonessential businesses forced to close their doors to the public should have no trouble proving an economic loss. Alternatively, if the plan’s annual safe-harbor notice included a statement that the employer may amend the plan during the year to reduce or suspend the safe-harbor contributions, then an amendment to eliminate the safe-harbor employer contribution could be effective at least 30 days after all eligible employees receive a supplemental notice of the effective date of the reduction or elimination of the safe-harbor employer contribution.
Since the safe-harbor exemptions from testing would no longer apply, the plan must perform the ADP and ACP for the entire year using current year testing and must provide a top-heavy contribution minimum for non-key employees-participants employed on the last day of the year. There is no 1,000-hour requirement in a defined contribution plan for a top-heavy allocation. The top-heavy minimum contribution is based on a total annual compensation definition (not just compensation while a participant).
An employer can also terminate an entire safe-harbor plan for cause. If the plan termination is for cause, the employer can terminate the plan without providing advance notice and the plan can retain its safe-harbor status, which means there is no danger of additional contributions due to a failed top-heavy test or failed discrimination testing, or corrective distributions needed in connection with failed ADP and ACP testing. A termination is for cause if it results from a substantial business hardship, a merger, acquisition, or other event that qualifies for the coverage transition rules. Employers should seek advice from an expert to complete a termination for cause.
True-up Match Contribution
True-up contributions typically come into play when the plan document specifies that the match must be determined on an annualized basis, but the plan sponsor (or the payroll system) actually calculates and deposits the match each pay period. More specifically, they occur when a participant defers above the maximum match threshold for some pay periods and below it in other periods.
A true-up match computation is best illustrated with an extreme example. Let’s say a participant chooses to contribute the maximum 402(g) limit plus maximum catch-up contribution for 2020 ($19,500 + $6,500 = $26,000) from his/her first paycheck of the year, a bonus of $100,000, but the payroll software only contributes the maximum match threshold of 3% of compensation, or $3,000, for that paycheck. If the software does not compute any additional match contributions for the rest of the year 2020, the participant will be owed an additional match contribution at the end of the year if the computation is based on annual wages. If this participant earns the maximum 401(a)(17) compensation for 2020 of $285,000, his allocable match contribution is $285,000 x 3% = $8,550, but the participant has only been allocated a match of $3,000, which means a true-up match contribution must be allocated to the participant. If a plan is amended mid-year to eliminate a discretionary match computed on an annual basis, a true-up match may be still be owed, even if compensation is prorated for the number of months the match provision was effective. Once again, eliminating a discretionary contribution does not mean that there is no further employer contribution required, which is a common misconception.
Fixed Profit Sharing and Matching Contributions
If the plan has a fixed employer contribution stated as a plan provision, the anti-cutback rules would protect participants who have satisfied the allocation provisions, such as a 1,000 hours of service requirement. Therefore, once a participant has completed the conditions for a contribution, the employer may not eliminate the contribution retroactively, but it could freeze any additional contributions from accruing prospectively. Plans that suspend any further accruals must prorate the payroll to compute the wages eligible for an employer contribution. If the employer contribution is deposited annually, it may not be possible to eliminate a contribution requirement for the year 2020. However, the amount owed can be decreased with a prospective suspension of the contribution and the employer can deposit in 2021 for 2020.
Sometimes, You Just Can’t Completely Escape
Like checking your work email on vacation, sometimes you just cannot escape a contribution commitment, even if it seems like it should be possible in theory. In these pandemic times, keep expectations realistic. Don’t assume that outcomes are possible if they seem to make sense. To keep track of all the complex rules surrounding the employer contribution calculation, it is important to seek the expertise of the appropriate service providers to ensure compliance.