The Impact of Layoffs and Furloughs on Retirement Plans

Some businesses are making the painful decision to lay off employees, while others have put employees on a temporary leave of absence or “furlough.” The distinction between a permanent termination and a furlough is especially important with some of the new CARES Act legislation. 

There’s no way around it: the coronavirus pandemic has changed the world. The swift and expansive response to flatten the curve has altered the status quo for everybody, and in the process has created an air of uncertainty for business owners concerned about keeping their employees at work. The decision to furlough or lay off employees is never an easy one. The prospect of a shifting workforce has major implications for the normal operations of a business, including the company 401(k) plan. 

As we speak with our clients around the country during this crisis, we’re hearing questions about the potential impact of layoffs and furloughs on retirement plans. Here are some of the most frequently asked questions—and our answers.

WHAT HAPPENS TO A FURLOUGHED EMPLOYEE’S 401(K)?

Because furloughed employees are still considered to be employed by your business, they will be ineligible to cash out their 401(k) as a terminated employee may be able to do. However, the CARES Act has broadened the potential reasons for taking a distribution.

WHAT HAPPENS TO A LAID OFF EMPLOYEE’S 401(K)?

Should you lay off employees, the implications are quite different. Terminated employees will have the same options with their 401(k) balance as employees who leave your company under any circumstances. As an employer, though, if you offer an employer match with a vesting schedule and you lay off more than 20% of your workforce in the same year, then all laid-off employees will immediately fully vest. (MAYBE) This does not apply to companies with routine turnover in this range.

IS SEVERANCE PAY CONSIDERED INCOME FOR 401(K) PURPOSES?

Severance pay would be considered compensation for a 401(k) plan under these circumstances:

• It constitutes either normal wages or wages above-and-beyond normal income, like overtime pay, a commission, or a bonus;
• It would have been paid to the employee if they hadn’t been laid off; and
• The payment is made either within 2.5 months after termination or by the end of the plan year, whichever comes first.

As long as severance pay fits all of those criteria, the terminated employee has the option to defer a portion of that income to the 401(k) plan—though they don’t have to.

WHAT HAPPENS TO A TERMINATED EMPLOYEE’S 401(K) LOANS? 

It’s common for 401(k) plans to require laid-off employees to fully repay an outstanding 401(k) loan upon termination. The 2017 tax reform bill has stretched the window for this repayment (or to roll the loan and account balance over to a new plan) from the original 60-day deadline to the same deadline as the individual’s income tax returns. That said, current circumstances are anything but normal. For that reason, the CARES Act contains provisions that can put a pause on 401(k) loan repayments for the rest of 2020. For more information about the specifics of these provisions keep reading.

HAVE 401(K) LOAN LIMITS INCREASED UNDER THE CARES ACT?

The Coronavirus, Aid, Relief and Economic Security (CARES) Act has adjusted 401(k) loan limits up to $100,000 or 100% of a participant’s account balance that is vested, whichever is lower. This only applies to 401(k) plans that allow loans and will be in effect until September 23, 2020. 

HAS THE CARES ACT LED TO CHANGES IN 401(K) LOAN REPAYMENT SCHEDULES?

In an effort to ease the financial burden, the CARES Act provides individuals a delay in existing loan repayment. If an individual has an outstanding loan due between March 27, 2020, and the end of the year, they can delay repayment for up to a year. This applies to qualified employees still working as well as qualified furloughed employees and those on a temporary leave of absence.

Interest on the outstanding loan will continue to accrue. Also, the plan can extend the term of the loan by up to a year to compensate for the suspension of repayment.

WHAT’S DIFFERENT ABOUT 401(K) DISTRIBUTIONS UNDER THE CARES ACT?

The CARES Act waives the additional 10% penalty tax on early withdrawals up to $100,000. Anyone who takes a distribution will need to pay income tax on those withdrawals. 

WHO QUALIFIES FOR THESE CARES ACT DISTRIBUTIONS AND LOAN EXTENSIONS?

In order to request a 401(k) loan repayment extension or withdrawal, an employee will need to verify that they qualify for one of the following reasons:

? They have been diagnosed with COVID-19

? They have a spouse dependent diagnosed with COVID-19

? They have been financially impacted by quarantine, job loss, or reduced hours due to COVID-19

? They were unable to work because of childcare needs caused by COVID-19

? They have experienced other factors determined by the Secretary of the Treasury

Note: You as the plan sponsor do not need to verify this information and may rely on the participant’s certification for eligibility.

CAN MY EMPLOYEES REPAY ANY COVID RELATED DISTRIBUTIONS THEY TAKE?

The CARES Act allows employees to repay COVID-19-related distributions back into a qualified retirement plan within a period of three years in order to avoid paying income taxes on the withdrawal. Those repayments would not be subject to normal retirement plan contribution limits. Additionally, if an employee chooses to take a withdrawal and pay income taxes rather than repay the amount, they can spread their income tax payments out over a three-year period.

CAN I UPDATE MY PLAN DOCUMENT TO ALLOW FOR LOANS AND DISTRIBUTIONS IN LIGHT OF THE CARES ACT?

If your 401(k) plan does not currently allow for loans or distributions, you are able to amend your plan to help employees take advantage of these rules, as long as you make the change on or before the last day of the first plan year beginning on or after January 1, 2020. 

EMPLOYEE GUIDANCE

If an employee is seeking guidance to help them decide whether or not to take a distribution or a 401(k) loan, here are some general guidelines for them. Generally speaking, it’s a good idea to tap into emergency savings before halting retirement contributions or taking money out of a retirement account. If a participant is facing an inability to keep up with basic living expenses and has no emergency savings, it may make sense to temporarily stop saving for retirement as a first measure.

Saving enough money for a dignified retirement requires steady saving and a disciplined investment strategy through market ups and downs. Significant pauses in saving, or early withdrawals of any kind, can have a long-lasting impact on retirement savings.

A proper financial advisor can help your participants explore the overall impact of any withdrawals or loans on their savings strategy so they have the full picture.

There is no pause button for retirement plans. As you continue managing your plan through unprecedented times, know that CPD is standing by to answer your questions, as well as those of your employees, to help you better understand the impact of COVID-19 on your business and finances. Contact us today to learn more about how we can help you provide a valuable retirement benefit with reliable service. WE are always turning numbers into ideas.