Many companies have had to make very difficult employment decisions during 2020. Those that were fortunate enough to receive a Paycheck Protection Program (PPP) loan may have been able to defer employment reductions in the short term. Unfortunately, for many businesses, the COVID-19 environment has lasted longer than the PPP loan funds. While companies make these difficult employment decisions, they should be aware of how the reductions impact their 401(k) plan.

Here are some of the most frequent questions that we have received recently from our clients:

How should you handle a furloughed employee’s 401(k) account?

Terminated employees are typically able to cash out, or rollover, their account balance. However, furloughed employees are still considered employed so they will be ineligible for a terminated distribution. Therefore, if a furloughed employee needs to access their funds, they will need to consider other distribution options depending on the plan’s design. A plan loan, age 59 ½ in-service distribution, or hardship distribution are some common alternatives.

Should we withhold 401(k) deferral on severance pay?

Yes, you should withhold 401(k) deferral if the consideration meets the following three conditions. First, the compensation constitutes normal wages which includes compensation for overtime pay, commissions, or a bonus. Second, it would have been paid to the employee regardless if they were terminated. And, third, the payment is made within 2 ½ months after termination or by the end of the plan year, which ever comes first. Keep in mind the employee has the option to opt out of the 401(k) deferral, if they prefer. Any such election should be retained in their personnel file.

Does a significant reduction in my total headcount impact my 401(k) plan?

If you plan requires vesting, then you will need to consider if the reduction in headcount results in a partial plan termination. Typically, a partial plan termination occurs when you have a 20% or more reduction in a year.  An employer who partially terminates a plan must make all affected participants 100% vested immediately. Keep in mind voluntary terminations are not considered for partial plan termination consideration.

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Managing the compliance requirements of your 401(k) plan can be challenging especially in light of changing environment, rules, and regulations from the Department of Labor and IRS. That’s why it’s important to have a clear understanding of the audit requirements, including exceptions, to ensure your plan maintains compliance. If you have questions or need assistance with an upcoming benefit plan audit, Barnes Dennig can help. For additional information please call us at 513-241-8313 or click here to contact us. We look forward to speaking with you soon.