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United States
New York , 14 April 2009

With the US in the grips of a prolonged recession, many organizations are exploring ways to preserve cash, including reducing or eliminating their contributions to 401(k) and other defined contribution (DC) plans. Although these actions may provide a relatively easy and quick way to reduce expenses, Mercer cautions employers to have a full understanding of the implications and potential pitfalls of taking this step in its latest update, Suspending the 401(k) match – Look before you leap.

An employer survey conducted by Mercer in November 2008 found that 17 percent were “likely” or “very likely” to suspend the contribution to their DC plans. But during the first three months of 2009 more than 80 major employers publicly announced plans to reduce or suspend their contributions. Contribution suspensions are particularly common within industries hit hardest by the economic downturn, including media, automotive, airlines, retail, hospitality and gaming, and to a lesser degree technology, manufacturing, health care and finance.

“Distressed organizations may feel they lack sufficient time or resources to carefully consider the impact of contribution reductions or to evaluate alternative approaches. But the effort invested up front could save considerable time and expense later in dealing with unintended consequences,” said Bill McClain, Mercer retirement consultant and author of Mercer’s update.

The scarcity of financial capital during the current economic downturn sets it apart from other recent downturns. While broad-based actions such as DC-plan match suspension may make sense for some employers, others will want to be more “surgical” in their efforts. A reduction in retirement benefits can have a significant impact on employee commitment and morale.

“While the loss of one year’s employer contribution won’t have a huge impact on an employee’s retirement benefit, it could represent yet another incremental loss to an already-weakened benefit,” said Mr. McClain. “Suspending contributions also results in a lost opportunity to purchase equities at historically low prices. These implications need to be weighed against the organization’s need to preserve capital.”

Companies should not lose sight of their longer-term business objectives, Mercer warns. “Many organizations will be better off identifying cost saving that will have only a minimal impact on those groups of employees that will be the most critical to helping them move forward once the economy improves,” said Mr. McClain.

Potential regulatory pitfalls

The regulatory implications of a match reduction or suspension can vary greatly from plan to plan. Employers maintaining an IRS safe harbor design are subject to specific rules or even restrictions on suspending or reducing contributions during the plan year. Other plan designs may offer more flexibility in terms of changing employer contributions, but even these plans must satisfy various regulatory requirements. In particular, employers need to understand whether a plan amendment is required and whether that amendment raises any anti-cutback issues. 

Plan sponsors should determine whether language in past employee communications could be interpreted as a promise to provide ongoing contributions. Organizations with collectively bargained or other employment agreements in place may be prevented from making company-wide changes to DC contributions.

Reducing or suspending employer contributions could have important implications for the plan’s non-discrimination requirements, which may be compounded by changes in compensation practices or participant behavior related to the economic downturn. To avoid surprises and potentially costly remediation, according to Mr. McClain, employers should consider projecting the impact of contribution changes on non-discrimination tests.

“Significant employee communication considerations exist when an employer suspends contributions to the DC plan,” said Mr. McClain. “Participants need to receive sufficient notice to allow them to change their deferral elections if they wish – and indeed safe harbor designs carry specific notification requirements. And any changes will need to be incorporated into the plan’s summary plan description and other communications, including online tools and vendors’ customer support.”

You can get the April 2009 Mercer Update, Suspending the 401(k) match: Look before you leap.

About Mercer

Mercer is a leading global provider of consulting, outsourcing and investment services. Mercer works with clients to solve their most complex benefit and human capital issues, designing and helping manage health, retirement and other benefits. It is a leader in benefit outsourcing. Mercer’s investment services include investment consulting and multi-manager investment management. Mercer’s 18,000 employees are based in more than 40 countries. The company is a wholly owned subsidiary of Marsh & McLennan Companies, Inc., which lists its stock (ticker symbol: MMC) on the New York, Chicago and London stock exchanges.

For more information, visit www.mercer.com

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