Suspension of 401(k) Safe Harbor Contributions

January 2014ERISA Alert

The Internal Revenue Service recently issued final regulations under Section 401(k) of the Internal Revenue Code which sets forth procedures for reducing or suspending safe harbor contributions to a 401(k) plan. The final regulations revise and supersede the proposed regulations that were issued in 2009.

Background

In order to avoid performing the discrimination testing required for 401(k) plans and to avoid having to take steps to correct a failure to pass such tests, many plan sponsors adopt a design-based safe harbor which is deemed to satisfy the testing if certain contribution and notice requirements are complied with. More specifically, an employer can make a safe harbor matching contribution equal to 100% of an employee’s elective contributions up to 3% of compensation and 50% of the employee’s elective contributions in excess of 3% and up to 5% of compensation. Alternatively, the employer can make a safe harbor non-elective contribution to all eligible non-highly compensated employees equal to 3% of compensation. Generally, the safe harbor contribution must be maintained for a full year.P>

Under the proposed regulations, the ability to reduce or suspend safe harbor matching contributions and safe harbor non-elective contributions during the plan year were subject to different requirements. In order to reduce or suspend safe harbor non-elective contributions during the plan year, the plan sponsor must demonstrate that it has incurred a substantial business hardship. It was not necessary to for the plan sponsor to have a substantial business hardship in order to reduce or suspend safe harbor matching contributions.

Final Regulations

Under the Final Regulations, the IRS sought to achieve uniformity in the rules for reducing or suspending safe harbor matching contributions and safe harbor non-elective contributions. Accordingly, in order to reduce safe harbor matching or safe harbor non-elective contributions during a plan year, the following conditions must be satisfied:

  • The plan sponsor is operating at an economic loss; or the safe harbor notice provided to participants for the year provided that: (i) the 401(k) plan may be amended during the year to reduce or suspend the safe harbor contribution; and (ii) a supplemental notice will be provided if the safe harbor contributions are reduced or suspended.
  • The 401(k) plan is amended to provide that the discrimination tests will apply for the full year.
  • The reduction or suspension of the safe harbor contributions is not effective until the later of: (i) the date the 401(k) plan is amended; or (ii) 30 days after the supplemental notice is provided to participants.
  • Participants are given a reasonable opportunity to change their salary deferral elections prior to the reduction or suspension of the safe harbor contributions.

The supplemental notice must explain to participants the consequences of the amendment that reduces or suspends the safe harbor contributions, the procedure for changing salary deferral elections and the effective date of the reduction or suspension of the safe harbor contributions.

The Final Regulations are effective for amendments adopted after May 18, 2009 with respect to amendments to reduce or suspend safe harbor non-elective contributions. For amendments to reduce or suspend safe harbor matching contributions during the year, the Final Regulations are effective for plan years beginning on or after January 1, 2015.

What To Do?

Beginning after 2014, employers may want to consider revising their safe harbor notice to specify that the safe harbor contribution may be reduced or suspended and that a supplemental notice will be provided in such case. By making such revisions in the safe harbor notice, employers can avoid having to demonstrate that they are operating at an economic loss should they desire to reduce or suspend their safe harbor contributions.

For more information on this Alert or other ERISA matters, please contact:

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