The COVID-19 pandemic has many employers making tough choices including reductions in force, reducing hours, and reducing compensation for employees. Employment decisions, in turn, affect employee benefit plans and policies.
Employers need to review their employee benefit plans and policies, as well as plan service provider contracts, to determine how employment decisions will affect employee benefit programs.
Complexities and traps for the unwary abound in employee benefits plans. Careful planning, which seems a luxury in these days of the COVID-19 pandemic, remains key to avoiding significant and substantial problems.
Emergency Paid Sick Leave and FMLA Expansion
The Families First Coronavirus Relief Act (FFCRA) was enacted on March 18, 2020, and generally requires employers with fewer than 500 employees to provide paid sick leave and additional FMLA benefits to their employees. For more information on emergency paid sick leave, please see the Families First Coronavirus Response Act (Legislative Alert #1).
Health and Welfare Plans
COVID-19 Related Health Plan Coverage
The Coronavirus, Aid, Relief and Economic Security Act (CARES Act) requires that group health plans cover certain preventive services and vaccines related to COVID-19. (See Essential Health Benefit Coverage.)
FFCRA requires group health plans to cover costs related to diagnostic testing for COVID-19 and related healthcare provider services (in-person and telehealth) and facility costs (including doctors’ offices, urgent care centers and emergency room) without requiring participants to share in the cost (e.g., deductibles, copayments or coinsurance). (See CMS Releases FAQs on COVID-19 Coverage under Catastrophic Health Insurance Plans.) In addition, FFCRA requires prior authorization and other medical management requirements to be waived with respect to COVID-19 services.
Eligibility for Health Coverage
Plan or policy terms will determine whether employees who are furloughed or who experience a reduction in hours can maintain their health coverage. Most plans require employees to satisfy minimum hour requirements to maintain eligibility for health coverage.
Employers should review plan provisions related to employees’ payment of premiums while on a leave of absence. Employers may be able to amend their plan or policy to expand coverage or modify the procedures for employee premium payments, subject to approval from the applicable insurance carrier. For insured health plans, expanding coverage to ineligible employees without the insurer’s consent could result in nonpayment of claims.
COBRA Continuation Coverage
COBRA continuation coverage must be offered to employees who are terminated or experience a reduction in hours making them ineligible for coverage under an employer-sponsored health plan.
ACA Employer Mandate
Pursuant to the ACA Employer Mandate, employers with an average of at least 50 full-time employees (i.e., averages 30 or more hours of service per week) must provide affordable health insurance that provides minimum value to its full-time employees in order to avoid exposure to a penalty tax under Section 4980H of the Internal Revenue Code (the “Code”).
Most employers track employees’ hours over a prior measurement period to determine eligibility for a plan year. If an employer is considering an employee furlough or reduction in hours and using a prior measurement period, then that employer should consider that participants who are full-time employees will retain their full-time status for the duration of the applicable plan year even if they are no longer full-time.
For calendar months in which the employee retains his or her full-time status and the medical coverage is not affordable, a tax penalty under Code Section 4980H(b) may be assessed if the employee obtains subsidized coverage through the Marketplace. Therefore, employers must consider whether subsidizing the employee cost of coverage is necessary or desirable for these employees.
Employers who are covered entities under HIPAA and their business associates are reminded that the HIPAA privacy and security rules continue to apply during the COVID-19 pandemic. In addition to the general continuing obligations, covered entities and their business associates with more employees working remotely should review and update their HIPAA privacy practices and work systems to provide that appropriate administrative, technical, and physical safeguards are maintained.
Cafeteria Plan Elections
Employees cannot make mid-year election changes based on a furlough or reduction in hours (e.g., change in employment status) to any coverage paid on a pre-tax basis through a cafeteria plan unless the election is consistent with the nature of the event. Therefore, employers should review their cafeteria plan documents to determine the circumstances in which changes are permitted for certain benefits and, if necessary, amend the plan to provide participants with additional options.
Amount of Welfare Benefits
The amount of certain welfare benefits is usually tied to an employee’s compensation (e.g., disability benefits and life insurance benefits offered as a percentage of pay). Thus, reductions in compensation can reduce the value of these benefits for employees. Employers should consider how to inform employees when benefits are reduced in this way.
Administration of Qualified Retirement Plans
During the COVID-19 pandemic and the resulting uncertain economic times, fiduciaries (including employers) of qualified retirement plans should pay particular attention to their fiduciary duties to act prudently, diversify plan assets and comply with plan provisions. Compliance with those fiduciary duties may require seeking expert advice, reassessing investment strategies, and rebalancing plan assets.
COVID-19 Legislative Changes to Qualified Retirement Plans
The CARES Act permits employers to expand participant access to certain retirement plan accounts for “coronavirus-related distributions” made from January 1, 2020 through December 31, 2020, up to a maximum of $100,000 or the participant’s vested account balance, whichever is less. These distributions are not subject to the 10% early withdrawal penalty and may be repaid to the plan over a 3-year period. Further, the income taxes due on these distributions may be paid over a 3-year period.
If your 401(k) plan permits participant loans, a participant will have the choice to take a loan rather than a taxable coronavirus-related distribution. The CARES Act increases the maximum loan amount available for certain qualifying individuals during the 180-day period beginning the date of enactment (ending September 22, 2020).
Prior to the CARES Act, loans were capped at the lesser of $50,000 or 50% of the participant’s vested account balance. The CARES Act raised the loan limits to the lesser of $100,000 or 100% of the vested account balance. The CARES Act also provides for an extended due date for existing loans.
Most qualified retirement plans permit hardship withdrawals in accordance with IRS safe harbor requirements. Those requirements do not permit hardship withdrawals for expenses and losses related to COVID-19without also qualifying under one of the existing safe harbor criteria. If a participant lives or works in a federally declared disaster area, the participant may be eligible for a hardship withdrawal to cover expenses and losses as a result of COVID-19.
Hardship withdrawals are subject to the 10% early withdrawal penalty for participants who have not reached age 59½ and are fully taxable in the year of the withdrawal. Therefore, a coronavirus-related distribution, as discussed above, might be a better option for participants.
Many defined contribution plans permit participants to elect to receive in-service distributions if they have reached age 59½. These in-service distributions are not subject to the 10% early withdrawal penalty.
In addition, recent changes in the law permit defined benefit plans to allow currently employed participants to elect to commence payment of benefits as early as age 59½. Employers have the option to adopt a plan amendment to expand or add in-service distribution provisions for defined contribution plans or defined benefit plans to help participants meet economic needs resulting from the pandemic.
Reducing or Freezing Benefits/Contributions
To reduce operating costs in the short term, employers may reduce or freeze benefits in their defined benefit plans or reduce or suspend employer matching or non-elective contributions in their defined contribution plans.
Freezing or reducing future benefit accruals under a defined benefit plan requires that participants and/or beneficiaries receive notice at least 45 days before the effective date of the reduction.
Discretionary employer matching and non-elective contributions may be suspended or reduced prospectively and may or may not require a plan amendment. Employers with safe harbor plans who decide to suspend or reduce matching or non-elective contributions must keep in mind that such changes are subject to additional requirements. When considering these modifications, employers should consider the IRS rules that prevent cutbacks in benefits. (See Review Plan Documents and More if Changing Employer Contributions to a 401(k) Plan.)
Voluntary Termination of Qualified Retirement Plans
An employer may determine it needs to terminate its qualified plans because of the economic downturn caused by the COVID-19 pandemic. Any employers doing so must realize that upon termination of a qualified retirement plan, all participants must be fully vested in their accounts under the plan. Further, those employers must consider the special rule that provides that an employer who terminates a 401(k) plan may not establish a new plan within 12 months following the termination, with some exceptions.
Partial Termination of Qualified Retirement Plans
A reduction in force of 20% or more of a qualified retirement plan’s participants in a particular plan year, that is not considered to be routine turnover, could result in the partial termination of the plan. If there is a partial plan termination, all affected participants are required to be fully vested in their accounts. Whether a partial termination of a plan has occurred requires an analysis of all of the facts and circumstances associated with the reduction in force.
Employee Benefit Plans and Service Contracts
Employers considering reductions in force need to review the terms of their contracts with the various service providers for their employee benefit plans (third-party administrators, investment advisors, trustees, etc.). A decision to reduce staff or reduce employees’ hours that affects the total number of eligible employees participating in a plan could result in increased fees under the contract.
Employers also need to consider that service providers are facing the same employment decisions and reduced staffing may impact the service provider’s abilities to meet its contractual obligations. Failing to properly administer an employee benefit plan can lead to major problems for the employers/sponsors of those plans under ERISA and the Internal Revenue Code.
Non-Qualified Deferred Compensation Plans
Section 409A of the Internal Revenue imposes strict rules as to the time and form of payment of certain incentive compensation and other nonqualified deferred compensation. Failure to adhere to the requirements of Section 409A can result in significant penalties and interest for employees and immediate taxation of all deferred amounts.
Employers may be subject to penalties for the failure to report compensation and withhold taxes properly. During the COVID-19 pandemic, employers need to be sure they are following Section 409A with respect to employee deferrals and payments under their non-qualified deferred compensation arrangements. Plan documents may need to be reviewed to determine whether any amendments are necessary and/or permissible to address issues raised by the economic impact of the pandemic.
Paying Annual Bonuses by March 15th
Many bonus plans are designed to take advantage of the “short-term deferral” exception from Section 409A and require payment by March 15th following the year in which the bonus was earned or became vested.
If as a result of the COVID-19 pandemic, an employer missed the March 15th deadline, then the employer may need to seek relief with respect to this deadline under the Section 409A regulations. The regulations provide that if making the payment by March 15th was administratively impracticable due to an unforeseen event or if payment would jeopardize the employer’s ability to continue as a going concern, and the payment is made as soon as possible after these conditions are alleviated, then the employer is in compliance with short term deferral exception to Section 409A.
Cancellation of Deferrals/Unscheduled Distributions
Generally, an employee’s deferral elections under a non-qualified deferred compensation plan must be irrevocable. An employee’s deferral election, however, may be canceled in the event of an unforeseeable emergency, if allowed under the plan document. An unforeseeable emergency includes an illness or an extraordinary and unforeseeable circumstance beyond the employee’s control (such as the COVID-19 pandemic) that creates a severe financial hardship which cannot be satisfied through other resources.
Employers may also permit a participant to receive a distribution in the event of an unforeseeable emergency if the plan provides for such distributions. Deferred compensation plan documents will need to be reviewed to determine whether the documents cover cancelation of deferrals or distributions in connection with an unforeseeable emergency and, if not, employers must consider whether an amendment would be appropriate.
An employer’s failure to make distributions in accordance with the participants’ elections and the terms of the plan is generally a violation of Section 409A. Many non-qualified deferred compensation plans provide for payment upon an employee’s separation from service. Complete termination or a reduction in hours could be considered a separation from service upon which the employee would be entitled to a distribution from the plan. Therefore, employers considering a reduction in hours for its employees should review their non-qualified deferred compensation plans to avoid an inadvertent distributable event or, alternatively, be prepared to process a timely distribution.
Stock options issued with an exercise price equal to the fair market value of the employer’s stock on the date of issuance are not subject to Section 409A. Employers may want to consider whether an updated stock valuation that takes the effects of the COVID-19 pandemic into account for valuation purposes prior to the issuance of any equity compensation is prudent.
Terminating Non-Qualified Deferred Compensation Plans
Employers considering terminating existing deferred compensation arrangements to distribute benefits to employees need to keep in mind that Section 409A only permits a voluntary plan termination and distribution of benefits under specific rules and those rules do not allow a termination in connection with a downturn of the employer’s financial status.
Any qualifying termination would require all similar nonqualified deferred compensation plans be terminated as well, and payments must be delayed until 12 months after the plan termination. Furthermore, the employer cannot adopt a new non-qualified deferred compensation plan of the same type for three years after the termination.
This article is not intended to cover all of the employee benefits issues that are likely to arise during the COVID-19 pandemic. The discussion of certain common issues and questions, however, may alert employers and plan participants to additional situations that will need careful consideration and reasoned responses. The Woods Rogers Tax and Employee Benefits teams of attorneys are ready to help should you have any questions.