An employer can adopt what is called a “safe harbor” 401(k) plan. Such a plan requires an employer to commit to making a specific contribution to each plan participant. In doing so, the plan is deemed to pass the annual Actual Deferral Percentage (ADP), the Actual Contribution Percentage (ACP), and the Top Heavy tests, which generally are annually-required discrimination tests that ensure that contributions do not impermissibly favor highly-compensated employees.
An employer must define what type of contribution it will make (for example, at least a non-elective 3 percent of pay contribution to employees; a basic match; or an enhanced match). The safe harbor regulations under Treas. Reg. §§ 1.401(k)-(3) and 1.401(m)-3 require the employer to issue a notice to participants prior to the beginning of the plan year informing them of which safe harbor contribution the employer has selected, as well as other details about plan features that remain in effect generally over the 12-month plan year.
The IRS typically restricts an employer from making mid-year changes to amend a safe harbor plan, which has been a source of frustration for employers who need to make mid-year changes for business reasons, but IRS Notice 2016-16, to be published in IRB 2016-07 (Feb. 16, 2016), provides guidance on limited, but permissible, mid-year changes:
The notice provides that a mid-year change either to a safe harbor plan or to a plan’s safe harbor notice does not violate the safe harbor rules merely because it is a mid-year change, provided that applicable notice and election opportunity conditions are satisfied and the mid-year change is not a prohibited mid-year change, as described in the notice.
While the IRS Notice is technical, the examples offered seem to offer a clear view on what the IRS deems a permissible mid-year change in many of the examples. For instance: Example 1 discusses an employer who chooses to raise its safe harbor non-elective contributions from 3 to 4 percent for all employees; employees receive an updated notice that describes the increased contribution (and an option for the employee to make a change to receive cash or alter deferred elections (“election opportunity”)).
Example 3 discusses an employer who, similar to Example 1, raises the safe harbor matching contribution from 4 to 5 percent (calculated no longer per payroll period, but rather on a plan-year period). The employer does this on August 31, with a retroactive effective date to January 1 of the same plan year and distributes an updated safe harbor notice (with the appropriate election opportunity).
Example 4 discusses an employer who makes a mid-year amendment to allow an age 59 ½ in-service withdrawal feature. The employer distributes the requisite updated safe harbor notice and election opportunity.
• It appears these above Example mid-year changes are permissible because the participants benefit with the plan amendments that the employer contemplates (and there is sufficient notice with the election opportunity). While an employer contemplating mid-year changes should evaluate the IRS Notice more closely, the rationale seems to borrow heavily from the anti-cutback analysis that the IRS uses to determine if a participant’s accrued benefits have been adversely affected under IRC § 411(d)(6)). The IRS Notice even makes reference to anti-cutback restrictions, general non-discrimination rules, and anti-abuse provisions.
In fact, in Example 2, where an employer wishes to decrease its safe harbor non-elective contributions from 4 to 3 percent, unless that reduction is tied generally to the employer’s economic loss or reservation of a right to reduce or suspend safe harbor contributions under Treas. Reg. § 1.401(k)-3(g), then the plan is no longer a safe harbor plan and, accordingly, must meet the nondiscrimination tests. Moreover, if the reduction does not meet the treasury regulation’s criteria, the plan as amended will not meet the ADP test under IRC § 401(k)(3).
The IRS Notice seeks comments from those 401(k) plan sponsors interested in additional guidance regarding mid-year changes to safe harbor plans, with a particular emphasis on those who might need guidance in the mergers and acquisition context or with plans having automatic contribution arrangements.