Layoffs vs. Furloughs: What’s the difference in terms of 401(k) impact?

Some businesses are making the painful decision to lay off employees, while others have put employees on a temporary leave of absence or “furlough.” The distinction between a permanent termination and a furlough is especially important with some of the new CARES Act legislation. 

There’s no way around it: the coronavirus pandemic has changed the world. The swift and expansive response to flatten the curve has altered the status quo for everybody, and in the process has created an air of uncertainty for business owners concerned about keeping their employees at work. And while the Paycheck Protection Program (PPP) is providing relief for some small business owners, the decision to furlough or lay off employees is never an easy one. The prospect of a shifting workforce has major implications for the normal operations of a business, including the company 401(k) plan. 

As we speak with our clients around the country during this crisis, we’re hearing questions about the potential impact of layoffs and furloughs on retirement plans, and how employers can apply for the PPP to keep their employees paid. Here are some of the most frequently asked questions—and our answers.

What happens to a furloughed employee’s 401(k)?

Because furloughed employees are still considered to be employed by your business, they will be ineligible to cash out their 401(k) as a terminated employee may be able to do. However, the CARES Act has broadened the potential reasons for taking a distribution.

What happens to a laid off employee’s 401(k)?

Should you lay off employees, the implications are quite different. Terminated employees will have the same options with their 401(k) balance as employees who leave your company under any circumstances. As an employer, though, if you offer an employer match with a vesting schedule and you lay off more than 20% of your workforce in the same year, then all laid off employees will immediately fully vest. This does not apply to companies with routine turnover in this range.

Is severance pay considered income for 401(k) purposes?

Severance pay would be considered compensation for a 401(k) plan under these circumstances:

  • It constitutes either normal wages or wages above-and-beyond normal income, like overtime pay, a commission, or a bonus;
  • It would have been paid to the employee if they hadn’t been laid off; and
  • The payment is made either within 2.5 months after termination or by the end of the plan year, whichever comes first.

As long as severance pay fits all of those criteria, the terminated employee has the option to defer a portion of that income to the 401(k) plan—though they don’t have to.

What happens to a terminated employee’s 401(k) loans? 

It’s common for 401(k) plans to require laid off employees to fully repay an outstanding 401(k) loan upon termination. The 2017 tax reform bill has stretched the window for this repayment (or to roll the loan and account balance over to a new plan) from the original 60-day deadline to the same deadline as the individual’s income tax returns.  That said, current circumstances are anything but normal. For that reason, the CARES Act contains provisions that can put a pause on 401(k) loan repayments for the rest of 2020. For more information about the specifics of these provisions, read our blog on CARES Act 401(k) loans and distributions.

Who qualifies for the Paycheck Protection Program?

Any business with 500 or fewer employees that has been negatively impacted by the coronavirus is qualified to apply. The Small Business Administration (SBA) has also extended eligibility to restaurants or hotels with 500 or fewer employees per location (businesses whose NAICS code begins with 72), tribal businesses, independently-owned franchises, self-employed workers, independent contractors, gig workers, and sole proprietors.

How do I apply for the Paycheck Protection Program?

The SBA is working with approved lenders as part of the existing SBA 7(a) loan program to administer PPP loans. You can apply with SBA approved 7(a) lenders, federally insured depository institutions, credit unions, and Farm Credit System institutions. Check with your primary bank or preferred lender to see if they are accepting applications online.

What documents are required for the Paycheck Protection Program loan process?

Different lenders have different requirements for documentation, often depending on your existing relationship with the institution (if any). In general, the SBA is asking lenders to verify average monthly payroll expenses using any of the following:

  • Payroll processor records
  • Payroll tax filings like IRS form 941
  • Form 1099-MISC
  • Income and expense reports

What if my primary bank denies my Paycheck Protection Program application?

Overwhelming demand is making it challenging for many lenders, especially large banks, to process PPP applications in a timely manner—or at all. If your PPP application is denied or left hanging, consider applying through a local community bank or financial technology platform. Multiple applications could trigger a fraud alert in the SBA system, so make sure your lenders will agree to contact you before finalizing your application.

What are the SBA PPP forgiveness rules?

The SBA has issued guidance that PPP loans will be fully forgiven if at least 75% of the proceeds are used for payroll, with the rest being used only for interest on mortgages, rent, and utilities. Forgiveness is also conditional on employers maintaining salary levels and, if applicable, rehiring employees who were laid off because of the COVID-19 pandemic. Any portion of the loan that is not forgiven will have a maturity of two years with a 1% interest rate, with repayments beginning six months following receipt of loan funds. For more information, review the Treasury Department’s Paycheck Protection Program FAQs.

Are employer 401(k) contributions considered a payroll expense for PPP forgiveness purposes?

Employer contributions to employee 401(k) accounts are considered a payroll expense by the SBA and will be counted as such in the calculation of loan forgiveness. The SBA clarified this point in their April 6, 2020 PPP FAQs document, giving employers confidence to continue or even accelerate contributions like an employer match, Safe Harbor contributions, or profit sharing contributions. Also note that while the PPP only offers forgiveness for up to $100,000 per employee, this limit only applies to cash compensation. The payment of non-cash benefits, like a 401(k) employer contribution, does not count towards the limit.

There is no pause button for retirement plans. As you continue managing your plan through unprecedented times, know that Fisher Investments 401(k) Solutions is standing by to answer your questions, as well as those of your employees, to help you better understand the impact of COVID-19 on your business and finances. Contact us today to learn more about how we can help you provide a valuable retirement benefit with reliable service, or click on a link below for more immediate answers to coronavirus-related 401(k) FAQs. 


Continued Reading on the CARES Act’s impact on 401(k) plans:

401(k) Plan Management During COVID-10: FAQs

CARES Act and RMDs: FAQs

CARES Act and 401(k) Loans and Distributions FAQs






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