Retirement and Health Plan Cost Reductions During a Financial Downturn or Recession

Carlton Fields
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Carlton Fields

Whether the economy is in a financial downturn or your particular organization is hitting a rough patch, at some point you will consider reducing costs. Welfare and retirement benefit expenses generally follow employee compensation, property and infrastructure, and the cost of goods for sale, in terms of significance. The following are some considerations to help you reduce employee benefit costs.

Prioritize Your Benefit Structure

In general, you want to target benefit programs that are costly or underutilized. Medical insurance and retirement benefits are often the most costly. As for utilization, examine participation numbers, as a lack of participation may indicate a lack of importance or a lack of appreciation. If you can, examine participation rates among various employee groups or classifications that will provide additional insights and allow reductions to spare certain groups of employees who may be more valuable to your organization.

Identify Your Options

Basic options include eliminating certain benefits and reducing employer contributions toward certain benefits.

Reduce Bonus Cash Outlays

If your company offers annual bonuses, it can provide for “payment” of those bonuses into a nonqualified plan. One of the benefits is that these plans are often “unfunded”; while someone qualifying for an $80,000 bonus will normally be immediately eligible for an $80,000 cash payment, if structured within a nonqualified plan, he or she would have an $80,000 “book account” that is not immediately paid from company assets. You may also be able to add a vesting requirement. For example, the individual might qualify for a bonus from service in 2020, but needs to be employed another three years to vest in that bonus.

Eliminate Employment Taxes

Ordinary compensation and bonuses are subject to employment taxes (FICA/FUTA, Social Security, Medicare), which are generally about 15%, with about 7.45% deducted from what would otherwise go to the employee and an equal amount paid separately out of employer funds. Employer retirement plan contributions are not subject to these taxes. A $1,000 payment to an employee will require the employer to pay about $1,075, and the employee will only receive about $925 (ignoring income taxes). However, a $1,000 employer contribution to a profit-sharing plan only costs the employer $1,000, and that entire amount goes into the participant’s account. Participants eligible for in-service distributions can immediately withdraw the $1,000, which will subject those amounts to income taxes, but not employment taxes.

The easiest way to take advantage of this tax savings is to restructure bonus payments as employer contributions. If you can adequately explain this benefit to certain employees, you could even reduce their salary and make up for it with an employer contribution, such as a $1,000 pay reduction coupled with a $1,000 guaranteed retirement plan contribution. If all employees are deferring at least a certain amount into a 401(k) or 403(b) plan, a company could reduce compensation by that amount and convert it to an employer contribution. For example, if all employees are deferring at least $1,000, a reduction in compensation by $1,000, coupled with a $1,000 employer contribution, will result in the same amount in their retirement plan account, but with a tax savings of about $75 to the company and the employee.

Early retirement incentives are another cash payment that can be restructured as an employer retirement plan contribution, and these work especially well with 403(b) plans that permit post-severance contributions.

Most of these options will require various documentation, including a board resolution or plan amendment. If you consider any of these options, it is important to determine the impact on your retirement plan’s nondiscrimination testing. If you select an option that will reduce employee compensation, you should confirm that doing so would not violate minimum wage laws.

Increase Cash Flow

Admittedly, this option does not reduce costs, but high costs can be offset with greater cash flow, and if increasing sales or output is not sufficient, you might be considering investors. A company can use its current 401(k) plan or adopt a new retirement plan that will be focused on investing in the company as an employee stock ownership plan (ESOP). Simply put, instead of a 401(k) plan investing in mutual funds, the 401(k) plan would invest in your company. Instead of employer contributions coming out of the general fund, the 401(k) plan would deposit funds into the general fund in exchange for stock, increasing cash flow. If a company is interested in this option, it should first conduct an independent assessment and valuation of the company to assess whether an ESOP is a viable option. Please do not hesitate to contact the author of this article for a referral to such an adviser.

Reduce Insurance Premium Payments

Applicable large employers will find it difficult to reduce the employer portion of medical insurance premiums due to the Affordable Care Act’s affordability requirements, but there still might be some leeway. For example, the ACA may require employers to pay a certain amount toward self-only coverage, but allows more flexibility with the amounts for spousal and family coverage. Similarly, ACA premium restrictions apply to general medical insurance, but not vision, dental, or many other coverages. Clearly, the most significant drawback to this cost-saving measure is that it forces employees to pay a greater portion of the premiums. Also, depending on the amount of the increase, the cafeteria plan rules (under IRC § 125) may require you to allow affected employees to drop or change their elections.

Reduce Medical Insurance Premiums

Often, the more people participating in a medical benefit, the lower the premiums. If your organization offers three or more coverage options, reducing the options may increase participation in the surviving options, driving down premium costs.

Reducing Retirement Plan Funding Costs

If your plan provides for an employer contribution or match, you may be able to reduce those expenses. Even if your plan is a safe harbor plan, IRS guidance allows safe harbor plans to change midyear under various circumstances, including financial distress. To mitigate the impact of this loss or reduction of benefits among your key executives, you can provide that smaller group with similar benefits through a nonqualified plan. We addressed this in a prior article available here.

Plan for Implementation

Once you know how you intend to reduce costs, consider the steps that will be required. Which service providers will be involved? What kind of employee communications will be important? Is board approval necessary? What about a formal plan amendment? If your organization uses employment contracts or collective bargaining agreements, they need to be reviewed to see if the desired change will breach the contract.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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