On January 29, 2016, the Internal Revenue Service (the "IRS") issued Notice 2016-16 (the "Notice") that provided long-awaited guidance (or relief from prior IRS guidance) on mid-year changes to safe harbor plans or to a safe harbor's plan required safe harbor notice.

A safe harbor plan design is used by a 401(k) plan[1] as an alternative to satisfying the annual actual deferral percentage ("ADP") or actual contribution percentage ("ACP") tests required under the Internal Revenue Code ("Code") to satisfy nondiscrimination requirements. The "safe harbor plan regulations" (Treasury Regulation Sections 1.401(k)-3 and 1.401(m)-3) set forth the requirements for a 401(k) plan to be considered a safe harbor plan. The safe harbor plan regulations specifically provided that a safe harbor plan could not make amendments to a safe harbor plan unless the amendments had been adopted before the first day of the plan year and had remained in effect for an entire 12 month period, with certain limited exceptions set forth in the safe harbor plan regulations or as provided in IRS guidance. IRS guidance and informal comments prior to the Notice indicated that any change to a safe harbor plan, other than those permitted by the safe harbor plan regulations or in an IRS Notice, were not permitted. Thankfully, this Notice changes that position!

Now, in addition to the previously expressly permitted mid-year changes to a safe harbor plan, the Notice provides that mid-year changes to a safe harbor plan can be made provided that: (i) if the mid-year change requires a change to the safe harbor notice content, that the safe harbor notice and election opportunity conditions in the Notice are satisfied, and (ii) the mid-year change is not a prohibited mid-year change as set forth in the Notice (or violates other restrictions on a plan, such as anti-cutback, nondiscrimination or anti-abuse).

Notice Requirement:

If a safe harbor plan's required notice would need to be changed, an updated safe harbor notice that describes the mid-year change and its effective date must be provided to each participant at least 30 days prior (not more than 90 days) to the effective date of the amendment ("Notice Prior to Amendment"). If it is not practical to provide the safe harbor notice 30 days in advance of the effective date, the notice is treated as timely if the notice is provided as soon as practicable, but not later than 30 days after the amendment is adopted ("Notice After Amendment"). In addition, each participant must be provided with a reasonable opportunity to change his or her cash or deferred election. This means a participant receiving (i) a Notice Prior to Amendment must be able to change his or her election within the 30 day period before the effective date of the amendment, or (ii) a Notice After Amendment must be able to change his or her election within the 30 day period after the amendment is adopted.

Although permitted, the following mid-year amendments must comply with special rules set forth in the safe harbor plan regulations:

  1. Adoption of a short plan year or any change to the plan year (permitted only as described in §§ 1.401(k)-3(e)(2), (3), and (4) and 1.401(m)-3(f)(2), (3), and (4));
  2. Adoption of safe harbor plan status on or after the beginning of the plan year (permitted only as described in §§ 1.401(k)-3(f) and 1.401(m)-3(g)); and
  3. Reduction or suspension of safe harbor contributions or changes from safe harbor plan status to non-safe harbor plan status (permitted only as described in 

§§ 1.401(k)-3(g) and 1.401(m)-3(h)).

Prohibited Mid-Year Amendments:

The following mid-year amendments are expressly prohibited unless required by applicable law to be made mid-year (i.e. mandated by statute or court decision):

  1. A mid-year change to increase the number of completed years of service required for an employee to have a non-forfeitable right to the employee's account balance attributable to safe harbor contributions under a QACA pursuant to the safe harbor rules under § 1.401(k)-3(k)(3) or 1.401(m)-3(a)(2).
  2. A mid-year change to reduce the number or otherwise narrow the group of employees eligible to receive safe harbor contributions. This prohibition does not apply to an otherwise permissible change under eligibility service crediting rules or entry date rules made with respect to employees who are not already eligible (as of the date the change is either made effective or is adopted) to receive safe harbor contributions under the plan.
  3. A mid-year change to the type of safe harbor plan, for example, a change from a traditional § 401(k) safe harbor plan to a QACA § 401(k) safe harbor plan.
  4. A mid-year change (i) to modify (or add) a formula used to determine matching contributions (or the definition of compensation used to determine matching contributions) if the change increases the amount of matching contributions, or (ii) to permit discretionary matching contributions. However, this prohibition does not apply if, at least 3 months prior to the end of the plan year, the change is adopted and the updated safe harbor notice and election opportunity are provided, and if the change is made retroactively effective for the entire plan year (which may require a plan that provides for periodic matching contributions as described in §§ 1.401(k)-3(c)(4) and (5)(ii) and/or 1.401(m)-3(d)(4) to be amended to provide for matching contributions based on the entire plan year).

MFEM Takeaway: The IRS has positively responded to many comments received from the benefits community by issuing Notice 2016-16. Previously, the IRS substantively prohibited mid-year changes other than in certain limited exceptions. This created uncertainty for plan sponsors of safe harbor plans involved in mergers and acquisitions, and plan sponsors who wanted to increase benefits under a safe harbor plan for the benefit of participants, change plan providers, or make amendments required to maintain a safe harbor plan's qualification. Notice 2016-16 and the request by the IRS for comments with respect to further guidance on mid-year changes with respect to mergers and acquisitions and other comments show a significant step by the IRS towards flexibility with respect to safe harbor plans. This may increase the use of safe harbor plans by plan sponsors who may have avoided adopting a safe harbor plan due to the previously strict interpretation by the IRS prohibiting most mid-year changes.