Scaling Back Benefits in Tough Times: IRS Allows Suspension of 401(k) Safe Harbor Nonelective Contributions
Current economic conditions have prompted many employers to consider reducing employee benefits, including contributions to 401(k) and other retirement plans. Last week the Internal Revenue Service (IRS) issued a proposed regulation that allows employers sponsoring a “safe harbor” 401(k) plan to reduce or eliminate in mid-year the nonelective 3 percent contribution.
An employer can avoid many of the complicated nondiscrimination tests associated with a 401(k) plan by adopting a “safe harbor” plan. In exchange for decreased annual testing, the Tax Code requires the employer to make a minimum contribution. The contribution can be in the form of a 3 percent nonelective contribution or a 4 percent matching contribution.
An underlying requirement of a safe harbor plan is that the employer must generally maintain the plan for a full plan year. Existing IRS regulations permit an employer with a safe harbor matching contribution plan to suspend matching contributions mid-year, provided the employer takes certain steps (as discussed in this advisory). The regulations are silent on whether an employer can terminate a 3 percent nonelective contribution mid-year, but the most reasonable reading of the regulations suggests an employer may not suspend contributions mid-year unless the entire plan is terminated.
Amending Plans Under the Proposed Regulation
The new proposed regulation specifically permits an employer to amend a safe harbor plan on or after May 18, 2009, to suspend a 3 percent nonelective contribution, provided the employer does the following:
Plan Amendment
The employer must amend its plan to prospectively suspend or reduce the safe harbor nonelective contribution. (See below regarding the delayed effective date of the amendment.) The plan amendment should also provide that the plan must satisfy the actual deferral percentage (ADP) test for the entire plan year, using the current-year testing method. The plan must continue to make the safe harbor contribution, and otherwise satisfy the safe harbor requirements, until the effective date of the amendment.
Advance Notice
Plan participants must be provided 30-day advance notice of the change.
30-Day Delay
Any amendment to suspend or reduce a safe harbor nonelective contribution cannot be effective before participants are given a 30-day advance notice of the suspension.
Hardship
The employer must have experienced a substantial business hardship in order to amend the plan mid-year to reduce or suspend safe harbor nonelective contributions. Factors to consider in determining whether a substantial business hardship has occurred include: (a) the employer is operating at an economic loss; (b) there is substantial unemployment or underemployment in the industry; and (c) industry sales and profits are depressed or declining.
Top-Heavy Compliance
A plan that suspends the safe harbor nonelective contribution must comply with the top-heavy requirements for the entire plan year (safe harbor plans are normally exempt from this requirement). Compliance with the top-heavy rules is required for the entire plan year.
Amending Plans Under Existing Regulations
As mentioned above, existing regulations already allow mid-year suspensions of safe harbor matching contributions, provided the plan sponsor satisfies the following requirements:
Plan Amendment
The employer must formally amend the plan to eliminate the matching contribution. The amendment must specifically provide that the plan will pass the ADP test and, if applicable, the actual contribution percentage (ACP) test for the entire plan year, using the current-year testing method. The amendment may not be effective for at least 30 days after participants have been provided notice (as discussed below).
Advance Notice
All participants must be provided at least 30 days’ advance notice of the change in the plan.
Opportunity to Adjust
All eligible participants must be given reasonable opportunity (including a reasonable period after receipt of the notice) to change their salary deferral elections.
Continued Contributions Through Effective Date
The plan must continue to satisfy the safe harbor requirements through the effective date of the amendment.
Top-Heavy Compliance
A plan that suspends safe harbor contributions must comply with the top-heavy requirements for the entire plan year (safe harbor plans are normally exempt from this requirement).
Applicability to Other Benefits
The concepts described above apply specifically to safe harbor 401(k) plans. Other types of plans may have different requirements for eliminating or reducing employer contributions. Employers considering a reduction in other types of benefits should seek advice that is specific to the plan and benefit in question.
Finally, note that our employment department recently held a client briefing “Beyond Layoffs: Controlling Payroll Costs in Creative and Legal Ways.” Materials and contact information can be found here.