Employers impacted by COVID-19 have a variety of questions regarding the impact on their retirement plans, including the ability to make contribution formula changes, questions about distributions, and compliance issues, which are addressed in this advisory. As this is a rapidly changing area, employers are strongly advised to consult with experienced benefits counsel before making any changes to their benefit plans.

Can furloughed employees take a distribution from our 401(k) plan?

While terminated employees can almost always tap their vested 401(k) plan accounts, the situation is not as clear for furloughed employees. The answer depends on the terms of the plan document; however, see below for general guidelines on options for “in-service” distributions that may be available to furloughed employees.


The Coronavirus Aid, Relief, and Economic Security (CARES Act) provides two optional provisions. First, a plan could be amended to allow for special withdrawals related to COVID-19, of up to $100,000, without the standard 10% early distribution penalty, repayable to the plan within 3-years, and with taxation spread over 3 years. Second, a plan could be amended to offer enhanced loans to those affected by COVID-19 up to the lesser of $100,000 or the full vested balance, for an extended term. See our CARES Act advisory for more details on these new provisions.

Age 59-1/2 distributions

Plans may permit any participant over age 59-1/2 to withdraw from their own salary deferral account, and sometimes from other vested accounts, even if still employed. Availability hinges on whether the plan document permits such distributions.

Hardship withdrawals

Aside from coronavirus-related distributions enacted by the CARES Act (as described above), plans may also allow “hardship withdrawals” for participants while employed (hardship withdrawals are permissible if the plan document provides for them, but they are optional). Hardship withdrawals are only allowed for certain defined expenses, some of which could be triggered by a furlough, such as incurring uninsured medical expenses or needing to prevent foreclosure or eviction. Another hardship category that recently became available applies to losses or expenses resulting from a FEMA-declared “major disaster.”

Several states have been declared “major disaster” areas due to Coronavirus, including New York, California, and Washington, and other areas may follow (the full list of states where a major disaster has been declared can be found on the FEMA website); elsewhere, the current “national emergency” is not sufficient to allow a hardship distribution. All hardship distributions are taxable and may be subject to the 10 percent early withdrawal penalty.

Plan loans

Aside from coronavirus-related loans allowed under the CARES Act (described above), plans can also allow participants to take ordinary loans from their account balances to help with almost any legitimate financial need. Unlike with coronavirus-related loans, a plan cannot increase the statutory $50,000 limit on ordinary loans that are outstanding, but it could make loans easier by relaxing rules on the number of loans that can be taken in a year or be outstanding at any time (note, this raises fiduciary concerns that should be addressed before permitting an increase in the number of loans). A participant who takes a plan loan is required to repay the loan at an interest rate set by the plan. Some plans require repayment of loans by payroll deductions. If a participant defaults on a loan by missing a payment, or terminates employment, the loan is generally treated as a distribution from the participant’s account balance with the attendant tax consequences.

Could terminations or furloughs cause a "partial termination" of our retirement plan, and what are the consequences?

Possibly, but not immediately. IRS guidance says that a 20 percent “turnover rate” during a plan year raises a rebuttable presumption that a partial plan termination has occurred. The turnover rate is the number of participating employees who have had an employer-initiated termination as of the end of the year divided by the sum of the participating employees at the beginning of the year plus participants added during the year.

Short-term furloughed employees who are recalled before the end of the year, therefore, should not count. If the plan does have a partial termination, the consequence is that all employees who are terminated during the year, whether employer-initiated or not, must be fully vested in their accounts if they are not already. The employer may thus lose the benefit of “forfeitures” by unvested employees that would otherwise occur during the year.

Because partial plan terminations are properly determined at the end of a year, employers should continue to apply vesting schedules to mid-year distributions, but be prepared for the possibility of a partial plan termination at year end. For example, if an employee who is subject to a temporary (hopefully) layoff requests an immediate plan distribution, the employer should pay only the vested amount. If the employee is called back in the same year, then the employee can continue to vest in the unvested amount. If at year end it is decided that a partial plan termination took place, the plan would fully vest the former employee’s account and pay out the balance.

Are cashouts for vacation time, sick pay, and other paid leave paid out after termination included in compensation for 401(k) plan purposes?

The answer will depend on the terms of the 401(k) plan. Post-severance leave cashouts, i.e., payments for accrued but unused sick pay, vacation, or other paid leave, paid after severance of employment can, but are not required to be, included in a 401(k) plan’s definition of compensation for contribution purposes.

If post-severance leave cashouts are included in a plan’s definition of compensation for these purposes, then a terminated employee who was a participant in that plan will be able to make deferrals, and may be able to earn matching and other employer contributions (if applicable), on leave cashout amounts paid to the employee, even if these amounts are paid after the employee’s severance from employment.

Can employers amend their 401(k) plans to eliminate or reduce matching or other employer contributions in the middle of the plan year?

Yes, with the caveats below, employers can generally amend their plans to reduce or eliminate employer or matching contributions in the middle of the plan year on a prospective basis, i.e., with respect to contributions made after the plan amendment’s effective date. Contributions will still need to be funded up to the amendment’s effective date.

Below, we provide general guidelines for different types of matching and employer contribution formulas. However, each plan is unique, and we strongly recommend consulting with experienced benefits counsel before implementing any such change.

Fixed formula contributions

A formal plan amendment will generally be required to eliminate or reduce matching or other employer contributions based on a fixed formula. Notice of the amendment must generally be provided no later than 210 days after the end of the plan year in which the change was effective. However, it is good practice to provide participants advance notice of the change to give them time to adjust their deferral elections.

Discretionary contributions

If a plan provides for discretionary matching or employer contributions, and the employer does not determine the amount of such contributions until the end of the plan year (e.g., in a profit-sharing plan), then an amendment may not be needed. The employer could simply decide at the end of the plan year not to make any contributions (or reduce their contributions) for that plan year.

Safe harbor plans

An employer that sponsors a safe harbor 401(k) plan may be able to reduce or eliminate matching or other employer contributions in the middle of a plan year if certain requirements are met. By way of background, a safe harbor 401(k) plan is a plan that requires the sponsoring employer to make a certain amount of matching and/or non-elective contributions each year, referred to as “safe harbor” contributions. The safe harbor contributions must meet certain other requirements (such as immediate vesting).

In exchange for making the safe harbor contributions, the plan is exempt from certain nondiscrimination testing under IRS rules. Nondiscrimination testing is designed to ensure that the employer’s highly-compensated employees (generally, employees who earn $125,000 or more annually) do not make or receive contributions to the plan in disproportionately high amounts above contributions made and received by non-highly-compensated employees. Safe harbor plans are also required to send a notice at the beginning of the plan year (known as the “safe harbor notice”) to participants describing their rights and obligations under the plan.

An employer is permitted to amend the plan to reduce or eliminate safe harbor contributions during the middle of a plan year if: (1) the safe harbor notice includes a statement that the employer may reduce or eliminate the safe harbor contributions during the plan year; or (2) the employer is operating at an economic loss (as defined in IRS rules). To amend the plan, the employer must also send a supplemental safe harbor notice to employees explaining the consequences of the plan amendment and how employees can change their deferral elections. In addition, the effective date of the plan amendment to reduce or eliminate safe harbor contributions cannot be earlier than 30 days after employees are provided the supplemental notice.

While reducing or eliminating “safe harbor” contributions mid-year is permissible if the conditions set forth above are met, it will result in the loss of safe harbor status, which will subject the plan to nondiscrimination testing for that plan year. If a plan fails nondiscrimination testing, a certain percentage of contributions made by or on behalf of highly-compensated employees may need to be distributed from the plan, among other potential corrective actions.

What are the rules regarding timely remittance of employee deferrals into 401(k) plan accounts?

The U.S. Department of Labor (DOL) has repeatedly stressed that business disruptions and associated cash crunches are not an excuse for delaying the transfer of employee elective contributions to a 401(k) plan. Generally, DOL rules provide that employee deferrals must be deposited in plan accounts as soon as they can “reasonably be segregated” from the employer’s general assets.

Although the DOL regulations technically provide an outside deadline of the 15th business day of the month following the month in which the payroll date occurred, the DOL takes the position that in this day of automated transfers, employers generally cannot rely on the outside deadline, since literally every payroll system (in the view of the DOL) is capable of segregating employee deferrals from their general assets quicker than the regulatory maximum deadline.

Sponsors of small plans, i.e., plans with fewer than 100 participants as of the beginning of the plan year, are subject to a seven-business-day safe harbor rule. Such plans will be deemed to be in compliance with the DOL rules if the deferrals are deposited in participant accounts within seven business days from the payroll date.

Was the deadline to make IRA contributions extended?

Yes, the IRS confirmed in FAQs that for 2020, contributions may be made to individual retirement accounts (IRA) at any time up to July 15, 2020 (extended from the usual deadline of April 15).

The facts, laws, and regulations regarding COVID-19 are developing rapidly. Since the date of publication, there may be new or additional information not referenced in this advisory. Please consult with your legal counsel for guidance.

DWT will continue to provide up-to-date insights and virtual events regarding COVID-19 concerns. Our most recent insights, as well as information about recorded and upcoming virtual events, are available at www.dwt.com/COVID-19.