The COVID-19 Pandemic Sheds Light on Questionable Retirement Plan Features
With many optional plan features, plan sponsors have a great deal of choice when it comes to designing their retirement plan: make the right choice and the plan is attractive to participants without being too difficult to administer; make the wrong choice and it may lead to the opposite situation.
During the COVID-19 pandemic, some optional plan features have come back to haunt plan sponsors. However, it is never too late to make a change - and hopefully the current crisis will provide the impetus for plan sponsors to act. Some of the questionable features include:
- Qualified Joint and Survivor Annuity (QJSA) — This is a standard form of retirement benefit in many plans, payable in the form of an annuity for the life of the participant, and, if the participant is married, a survivor annuity for the life of the spouse, payable upon the death of the participant. The survivor annuity percentage is specified by the plan and must be at least 50% (but no more than 100%) of the annuity benefit that was payable when the participant was alive (typically it is 50%). Confused thus far? Most participants are as well, which is why they almost never elect this benefit (or any other annuity benefit, for that matter). Instead, they tend to opt for lump-sum or partial distributions. The problem for plans that offer this benefit is that notarized spousal consent, or consent personally witnessed by a designated employee, is required for the participant to elect any form of distribution other than the QJSA. This has always been an administrative burden since it effectively prevents paperless distributions and loans. During a pandemic, it is easy to see why obtaining consent such as this may be difficult, since notarization is an in-person transaction. Virtual notaries have sprung up in a number of states; however, even that can be problematic for retirement plans. Fortunately, the QJSA is not a requirement for many plan types, and retaining it makes little sense if it can be avoided (in some plans, such as 403(b)s, it can be difficult to eliminate the provision).
- Loan offset at termination of employment — In most 401(k) plans (and some 403(b) plans) a participant cannot continue loan repayments if he/she terminates employment with the sponsoring employer. Instead, the entire outstanding loan balance is offset from a participant’s account balance. This has always been a problematic provision, since it unnecessarily erodes retirement savings; however, it has become a disaster during the pandemic, as laid-off participants have an additional tax burden at, presumably, the worst possible time. Fortunately, COVID-19 affected participants, as defined under the CARES Act, are able to spread the taxes out evenly on the distribution, avoid the 10% penalty, and repay the distribution within three years. Despite these changes, providing participants with flexibility for loan repayment at employment termination is far preferable.
- Fixed (as opposed to discretionary) employer contribution formulas — For many retirement plans, the plan document contains language stating that the employer contribution is discretionary and can be modified at any time and for any reason. For these plans, reducing or suspending the contribution is simple and can be done immediately. This is true whether the contribution is a matching or non-elective (base) contribution. This flexibility became an administrative advantage for employers who wished to suspend/reduce contributions during the COVID-19 pandemic, due to financial reasons. Even in a non-pandemic environment, it seems prudent for a retirement plan to be written, if possible, so that the plan sponsor has the flexibility to modify/suspend contributions at its discretion.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.
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