As a result of recent market and economic changes due to COVID-19, we expect that plan sponsors of cash balance (CB) and traditional defined benefit (DB) retirement plans will be impacted with increased funding requirements.
Plans are required to make minimum contributions annually. The minimum amount is based on several factors including mandated interest rates and the market value at the end of the preceding calendar year.
The recent staggering market downturn has likely reduced the assets in your DB and CB plans.
This won’t have an impact on the contribution recommendations for 2020 because those will be based on asset values as of 12/31/2019. If the market does not rebound by the end of 2020, however, the 2021 minimum contribution could be substantially higher due to the investment performance significantly underperforming the assumed rate of return and also record low interest rates, which have an inverse relationship to plan liabilities.
Another factor to consider is whether the profitability of your business will be negatively impacted in 2020 and beyond. Those businesses that can afford to make larger contributions to make up for the asset deficiency are generally allowed to do so. However, if you are unable to make the minimum contribution, there could be significant financial penalties/excise taxes that come into play, including higher Pension Benefit Guaranty Corporation premiums for applicable plans.
Many plan sponsors are attempting to conserve cash in light of COVID-19 and the economic realities that are wreaking havoc on businesses. If you have concerns about your ability to make future contributions, you may want to freeze or reduce the benefit formula(s) for the plan.
Although these options may not eliminate contributions, they can help meet employers’ objectives in conserving cash to weather the downturn. Note that if economic conditions improve, a freeze can be removed before the end of the year.
There is some urgency about this decision as the amendment must be adopted before anyone works 1,000 hours in 2020, or generally by June 1. In addition, a required 204(h) notice to employees outlining the reduction in benefit must be provided within 15 days prior to the amendment.
Note that start-up plans will not be impacted as dramatically as plans with substantially larger asset pools that will require significantly higher contributions in the future to cover the funding shortfall. Also, many smaller employers sponsor a 401(k) / profit sharing plan, which enables them to reduce discretionary contributions in that plan, as well as owner elective deferrals, to provide additional opportunities to increase cash flow, while offering more flexibility to determine whether or not to continue sponsoring a DB/CB plan.
There is a possibility that Congress will pass legislation providing funding relief in light of how dramatic the impact could be. Even if there is relief, it is unlikely that any relief will be known prior to when employees will have earned 1,000 hours of service.
Please contact us if you have any questions on how to mitigate the impact of the coronavirus pandemic upon your plan.
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