Nonqualified Plans and the American Pandemic, COVID-19
The new coronavirus, COVID-19, has created great social and economic uncertainties for companies, their employees and families. This article provides helpful information to assist nonqualified plan sponsors in answering the most common questions they may be receiving from their participants. In this brief newsletter we will have answers to these questions including:
- How participants may access their nonqualified plan accounts
- Whether deferrals may be suspended
- How to manage the plan in response to other human resources decisions including reductions in pay, changes to bonus programs, and temporary changes in employee’s status with the employer
It is important for plan sponsors and participants to remember that nonqualified retirement programs are designed for long-term capital accumulation purposes often stretching 15 to 30 years in duration. When individuals tap into these accounts, their long-term savings will be greatly compromised, and the spirit of these programs will be defeated. Financial advisors should remind participants in nonqualified plans to turn to other sources of liquidity and leave their retirement plans alone.
Access to Nonqualified Plans and Accounts
There are three ways to access limited amounts from a nonqualified plan.
1. Unforeseeable Emergency Requests
2. Small Balance Cash Out
3. Payments from Pre 409A, Grandfathered Accounts
1. Unforeseeable Emergencies
An unforeseeable emergency may include the imminent foreclosure of/or eviction of one’s primary residence. A reduction in pay by itself, will generally not qualify as an unforeseeable emergency.
- Unforeseeable emergency is limited to each participant’s individual circumstance and must be determined on a case-by-case basis. Emergency measures taken by the employer, such as an across the board pay reduction, does not automatically mean that each participant will individually qualify for distribution from the plan.
- The distribution is limited to the immediate need. The immediate need is the dollar value of the need after the participant’s other sources have been exhausted. The CARES Act and other financial relief packages may provide additional resources for participants impacted by the new coronavirus.
2. Small Balance Cash Out
The plan may provide, or be amended to provide, the employer with the discretion to distribute small balance accounts to a participant at any time. The participant’s combined accounts under all other nonqualified plans maintained by the employer’s control group of organizations must not exceed $19,500 and the distribution must be a complete liquidation of the accounts. Elective deferrals that are expected to be made for the remainder of the year should be factored into the determination of the account balance as well.
3. Pre 409A, Grandfathered Accounts
Amounts deferred into nonqualified arrangements dated on or before December 31, 2004 that continue to be paid through the terms of the pre-409A arrangements may be accessed. Many of these arrangements provide for discretionary withdrawals, provided the participant’s account balance is reduced by a designated percentage of the withdrawal.
Nonqualified plans, other than pre-409A grandfathered plans, may be terminated only for business reasons and not with a purpose to accelerate payments from the plan. In order to separate business driven terminations from acceleration driven terminations, the 409A regulations require liquidated payments to be delayed at a minimum of 12 months, and the Board of Directors must take final action to terminate the plan. Distribution will also violate 409A if the Board’s action to terminate occurs in connection with a downturn in the financial health of the employer.
Some participants may want to suspend their deferrals to increase their existing take home cash flow. Generally once deferrals commence for the calendar year, they may not be suspended. Exceptions include suspension due to unforeseeable emergency or disability.
As you can see, nonqualified plans should not be thought of as a primary source for liquidity during troubling financial times. There are strategies during the pre-enrollment period for employees to limit and bracket what they will defer, but once the plan is in motion, it is hard to stop it. As a reminder, it is best to think of deferred dollars as long-term resources, and you should always build an emergency fund to get you through these challenging times.
Should you have further questions please do not hesitate to contact an EBN consultant.