While employers scramble to stay afloat by cutting expenses during Covid, employees of some organizations may find their 401(k) match has been suspended.
Many businesses are facing a limited cash flow and this in turn can lead to a tightening of expenses leaving your 401(k) match as a potential target. Sarah O’Brien shares in a CNBC personal finance article, “employers are exploring how to trim their obligations to those plans without violating federal regulations” (O’Brien, 2020).
401(k) plan basics
Many are familiar with the basics of how a 401(k) plan works from the employees perspective. The employee makes pre-tax contribution and receives an employer match with earnings being allowed to grow tax deferred until distributed. However, not everyone knows why employers find setting up a 401(k) plan to be such an attractive opportunity. When employers set up a 401(k) plans they can make contributions and receive matches from the business just like the employees. In 2020, 401(k) max annual contributions is set at $57,000 with a $6500 catch up for those age 50 and over. They also receive certain tax credits for establishing the plan and their matching dollars generate a tax deduction (Lots of Benefits – when you set up an employee retirement plan). Certain testing is required to assure the plan is not favoring only the top earners of the firm.
To further illuminate why the 401(k) match is so important, in a recent MarketWatch article by Alicia H. Munnell, she explains the, “presence of an employer match produces a large initial return on the employee’s contribution that supplements the benefits of tax deferral and encourages participation”. More simply put, it can be a great tool for retaining talent. But what happens if your employer has to make changes to the plan due to an economic cash squeeze. They may consider suspending the 401(k) match.
Can they do this?
Yes, your employer can and may indeed suspend your 401(k). Your employer should first give you, the plan participant, 30 days notice of their intent to suspend (O’Brien, 2020). IRS Notice 2020-52 acknowledges and indicates, “During the ongoing COVID-19 pandemic, many employers are facing unexpected financial challenges. The Treasury Department and IRS have received comments that, as a result of these unexpected financial challenges, employers may need to reduce or suspend contributions under their safer harbor plans in order to satisfy payroll and other operating costs” (Internal Revenue Service 2020).
How long should you expect the suspension to last? The practice of 401(k) match suspension has happened before and as recently as the 2008/2009 financial crisis. Back then, more employers announced they would be cutting or suspending their 401(k) match, but not all made this implementation. It has been found that “plan sponsors who actually did cut or reduce the employer contribution restored it fairly quickly” (Wallace, 2020). This is encouraging if you are trying to gauge what we are experiencing today, but similar results may or may not apply.
Often while employees are being encouraged to sign up for their employers 401(k) plan they hear phrases like, take advantage of the plan, your employer is providing you with free money. While a suspension of employer matching is going to put the breaks on these additional funds being added to your retirement account, it is usually not advised to stop contributing on your own. Think about this, the suspension of your 401(k) match is due to the economic down turn. When the economy is down, you may be buying shares at a reduced price, so this actually may be the ideal time to increase your contributions, not reduce (Wallace, 2020). Of course you need to assess your cash flow first to see if this is a feasible strategy.
Other important concepts to remember, when you contribute to your 401(k) you reduce your earned income which may keep you in a lower tax bracket and your 401(k) contributions grow tax deferred. These can be big benefits.
Consider increasing your contribution to offset what you are losing from your employer match suspension. This will keep your retirement rate of saving in line. Hypothetically, this is how you would proceed:
Prior to the pandemic, you contributed 6% of your salary and you received an employer match of 3%. Now the match will be gone temporarily, but if you can increase your contribution to 9% you won’t be missing out on your financial plan objectives (Wallace, 2020). If your employer plan allows for Roth contributions, you could direct the additional 3% contribution to the Roth side of your 401(k) without effecting a change to your earned income. With contributions going to the Roth portion of your 401(k) you will be saving in a way which allows you to take distributions in retirement on a tax free basis. Again, you will need to assess your cash flow first before you implement this strategy.
Employers are getting creative with their expense saving game plans. 401(k) plans have provided a great strategy for employers and employees to build a financial nest egg for retirement, but now the employer match may be at risk. Employer suspended matching is not a new expense saving tactic used by employers. However, it is a benefit to all when the match is restored quickly. When faced with a suspended match, it is a good idea to stick with your disciplined saving strategy by continuing your 401(k) contributions. Consider making up the missing match yourself by contributing even more money if possible and direct this portion as a Roth contribution for tax free distributions in the future. Look carefully at your budget so you can assess your cash flow. This will allow you to better understand the overall impact of changes to your contributions.
About the Author
My name is Marianne Martini Nolte, CFP® As a Certified Financial Planner™ practitioner, I provide fiduciary financial advice and services for individuals, families, and small business owners. In particular, I have a passion for working with women in transition, new investors just starting on their path to financial independence, and families seeking special needs planning. This article is intended as a high level view. For more in depth information, please reach out:
Marianne Martini Nolte, CFP®
Imagine Financial Services
Phone, (760) 846-2569.
Home: Internal Revenue Service. (n.d.). Retrieved July 24, 2020, from https://www.irs.gov/pub/irs-drop/n-20-52.pdf
Lots of Benefits – when you set up an employee retirement plan. (n.d.). Retrieved July 24, 2020, from https://www.irs.gov/retirement-plans/plan-sponsor/lots-of-benefits-when-you-set-up-an-employee-retirement-plan
O’Brien, S. (2020, April 02). Employers may drop 401(k) matches as companies look to cut expenses. Retrieved July 24, 2020, from https://www.cnbc.com/2020/03/31/employers-may-drop-401k-matches-as-companies-look-to-cut-expenses.html
Wallace, K. (2020, April 21). What to Do If Your Employer Cuts Its 401(k) Match. Retrieved July 24, 2020, from https://www.morningstar.com/articles/979139/what-to-do-if-your-employer-cuts-its-401k-match
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