IRS Allows Mid-Year Changes to Section 401(K) Safe Harbor Plans

February 5, 2016 ERISA Alert

On January 29, 2016, the Internal Revenue Service issued Notice 2016-16 (the "Notice") which provides guidance on mid-year changes to safe harbor plans under Section 401(k) of the Internal Revenue Code.

How Does This Guidance Affect Plan Sponsors?

1. Mid-year changes now permitted: Plan sponsors with safe harbor 401(k) plans now have the opportunity to make adjustments to their plans during the course of the year as circumstances warrant without having to wait until the next year.

2. A safe harbor plan may now be the appropriate choice: By eliminating the uncertainty about the ability to make mid-year changes, plan sponsors who were reluctant to adopt safe harbor plans because they wanted to retain flexibility to make mid-year changes to their plans should revisit whether a safe harbor plan design may now be appropriate.

Safe Harbor Plans and Notices

In order to avoid performing the costly and time-consuming nondiscrimination tests required for a 401(k) plan to remain qualified, many plan sponsors design their 401(k) plans to satisfy the safe harbor rules under the Code. Under these rules, the 401(k) plan could provide:

i. a non-elective contribution to non-highly compensated employees of at least 3% of compensation,

ii. a matching contribution equal to 100% of an employee's contribution up to 3% of compensation, and

iii. 50% of an employee's contribution in excess of 3% of compensation up to 5% of compensation, or

iv. a qualified automatic contribution arrangement which requires employees to opt out of making specified levels of contributions.

With limited exceptions, the safe harbor rules must be adopted before the beginning of a plan year and continue for an entire 12-month period. Employees must also be provided notice within a reasonable period before the beginning of the plan year about the rights and obligations of the safe harbor arrangement (a "Safe Harbor Notice").

Under the Notice, routine changes in the Plan or the Safe Harbor Notice are permitted without violating the Code and the safe harbor rules. For example, under the Notice it would be possible to increase future safe harbor contributions or change the plan's default investment fund mid-year. In making a mid-year change, within a reasonable period before the effective date of the change, employees must be provided with an updated Safe Harbor Notice. Whether the timing of the updated Safe Harbor Notice is reasonable is based on all of the relevant facts and circumstances. However, it is deemed satisfied if it is distributed at least 30 days but not more than 90 days before the effective date of the change. In addition, each employee must be given a reasonable opportunity to change the employee's contribution election before the effective date of the change.

Prohibited Mid-Year Changes:

The Notice identifies the following mid-year changes as prohibited for a safe harbor plan, unless the mid-year change is required by applicable law:

i. a change to increase the vesting requirement attributable to an employee's account balance for safe harbor contributions under a qualified automatic contribution arrangement,

ii. a reduction in the number or the narrowing of the group of employees eligible for safe harbor contributions,

iii. a change in the type of safe harbor plan, and

iv. a modification to the formula used to determine matching contributions if the change increases the amount of matching contributions or permits discretionary matching contributions.

For more information on the issues in this alert, or ERISA matters generally, please contact:

Fred R. Green at [email protected] or +1 212 592 5910

© 2016 Herrick, Feinstein LLP. This alert is published by Herrick, Feinstein LLP for informational purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.