Suspend the 401(k) Match? Issues to Weigh, Pitfalls to Avoid

By Stephen Miller Apr 20, 2009
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Suspending employer contributions to a defined contribution (DC) retirement plan can provide a relatively easy and quick way to reduce expenses. But it can also damage employee morale and increase the risk of failing annual nondiscrimination tests and running afoul of other regulatory requirements. Employers should have a full understanding of the implications and potential pitfalls before taking this action.

An employer survey conducted by Mercer in November 2008 found that 17 percent were “likely” or “very likely” to suspend the contribution to their DC plans. But during the first three months of 2009 more than 80 major employers publicly announced plans to reduce or suspend their contributions. According to an April 2009 alert from the consultancy, contribution suspensions are particularly common within industries hit hardest by the economic downturn, including media, automotive, airlines, retail, hospitality and gaming, and to a lesser degree technology, manufacturing, health care and finance.

“Distressed organizations may feel they lack sufficient time or resources to carefully consider the impact of contribution reductions or to evaluate alternative approaches. But the effort invested up front could save considerable time and expense later in dealing with unintended consequences,” says Bill McClain, a Mercer retirement consultant.

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To avoid unintended consequences, consider the impact
of a match suspension and evaluate alternative approaches.
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The scarcity of financial capital during the current recession sets it apart from other recent economic downturns. While broad-based actions such as DC plan match suspension might make sense for some employers, others will want to be more “surgical” in their efforts, McClain says.

“While the loss of one year’s employer contribution won’t have a huge impact on an employee’s retirement benefit, it could represent yet another incremental loss to an already-weakened benefit,” says McClain. “Suspending contributions also results in a lost opportunity to purchase equities at historically low prices. These implications need to be weighed against the organization’s need to preserve capital.”

Companies should not lose sight of their longer-term business objectives, McClain warns. “Many organizations will be better off identifying cost saving that will have only a minimal impact on those groups of employees that will be the most critical to helping them move forward once the economy improves.”

Warning: Regulatory Roadblocks

The regulatory implications of a match reduction or suspension can vary greatly from plan to plan. Two potential regulatory pitfalls are noted below, along with preventative action steps recommended by McClain.

Potential pitfall: Employers maintaining an IRS “safe harbor” design are subject to specific rules or even restrictions on suspending or reducing contributions during the plan year. Other plan designs might offer more flexibility in terms of changing employer contributions, but even these plans must satisfy various regulatory requirements. In particular, employers need to understand whether a plan amendment is required and whether that amendment raises any anti-cutback issues.

Action step: Plan sponsors should determine whether language in past employee communications could be interpreted as a promise to provide continuing contributions. Organizations with collectively bargained or other employment agreements might be prevented from making companywide changes to DC contributions.

Potential pitfall: Reducing or suspending employer contributions could have important implications for the plan’s nondiscrimination requirements, which might be compounded by changes in compensation practices or participant behavior related to the economic downturn.

Action step: To avoid surprises and potentially costly remediation, employers should consider projecting the impact of contribution changes on nondiscrimination tests.

Notice and Communications

“Significant employee communication considerations exist when an employer suspends contributions to the DC plan,” comments McClain. “Participants need to receive sufficient notice to allow them to change their deferral elections if they wish—and indeed safe harbor designs carry specific notification requirements. And any changes will need to be incorporated into the plan’s summary plan description and other communications, including online tools and vendors’ customer support.”

Difficult Choices

Just as the practice of individual participants taking loans from their 401(k) accounts can have negative consequences but is sometimes unavoidable, so too may some plan sponsors find that suspending the 401(k) match is the least worst of their available options.

"Many employers find themselves struggling with this recession and having to make similar touch decisions," observed Heather Bader-Abrigo, an associate with the law firm of Reish Luftman Reicher & Cohen practicing in the areas of corporate and employee benefits law. "The reduction or suspension of the safe harbor matching contributions can provide much needed financial relief to employers. During these harsh economic times, this is one option, among several, that employers can utilize to help with cash flow," she recently wrote in the firm's April 2009 Report to Plan Sponsors newsletter.

Stephen Miller is an online editor/manager for SHRM.

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