The Internal Revenue Service (IRS) has issued Notice 2016-16,  which provides plan sponsors with clarity regarding the adoption of certain mid-year changes to safe harbor 401(k) plans. 

  • A safe harbor plan is a 401(k) plan which complies with certain matching or nonelective contribution requirements in order to avoid having to comply with nondiscrimination tests that may limit the salary deferral contributions and matching contributions that more highly compensated employees may receive for a plan year.
  • A mid-year change is either a change that is first effective during a plan year, but not effective as of the beginning of the plan year, or a change that is effective as of the beginning of the plan year, but is adopted after the beginning of the plan year.

For example, let’s say a calendar year plan is amended on June 15th to permit hardship withdrawals effective July 1st. The change is first effective during the plan year, but is not effective on January 1st, the first day of the plan year. This is a mid-year change.

Under the new rules, a mid-year change does not violate the rules that apply to safe harbor plans if the following requirements are met:

  1. Notice of the Change. If the change affects a plan provision that is required to be included in the annual safe harbor notice, an updated safe harbor notice that describes the change and its effective date must be provided to each employee otherwise required to receive the annual notice within a reasonable time before the change is effective.
    • The IRS considers notice of at least 30 days, but not more than 90 days, before the effective date of the change to be reasonable.
    • If it’s not practicable to give advance notice before the effective date of the change, the notice should be provided as soon as practicable, but not later than 30 days after the change is adopted.
    • If the required information about the mid-year change is described ahead of time in the annual safe harbor notice distributed before the plan year begins, there is no requirement to re-distribute the notice when the change becomes effective.
  2. Opportunity to Change Deferral Election. Each employee must have reasonable opportunity after receiving the updated notice to change salary deferral elections before the effective date of the change.
    • The IRS considers a 30-day election period as reasonable. For plans that allow deferral election changes at any time, this requirement should not be a problem.
    • In situations in which later notice is permitted under Number 1 above, the start of the election period may be delayed, but not later than 30 days after the date the change is adopted.

The following mid-year changes are not allowed, even if the notice and election rules described above are followed, unless required by a change in the law:

  • Increasing vesting requirements under a qualified automatic contribution arrangement;
  • Reducing or otherwise narrowing the group of employees eligible to receive safe harbor contributions;

ExceptionChanges to the eligibility service crediting rules or entry date rules made with respect to employees who have not yet become eligible for safe harbor contributions are permitted;

  • Changing from one type of safe harbor plan to another type; or
  • Modifying or adding the matching contribution formula or the definition of compensation used to calculate matching contributions if the change increases the amount of matching contributions, or amending the plan to permit discretionary matching contributions.

Exception: If this type of change is made at least 3 months prior to the end of the plan year, the notice and election rules described above are implemented, and the change applies retroactively to the first day of the plan year, the IRS will allow it.

The new rules also apply to 403(b) plans that rely on the safe harbor rules to satisfy nondiscrimination tests that apply to matching contributions.  These changes to the rules governing mid-year changes to safe harbor plans will be welcomed by most plan sponsors.  The IRS requested comments on whether additional rules are needed to address mid-year changes relating to employers that are involved in mergers and acquisitions.  Additional rules in that area will also be helpful to many plan sponsors.