On January 29, 2016, the Internal Revenue Service (the "Service") issued Notice 2016-16 (the "Notice"), the long-anticipated guidance on mid-year amendments to "safe harbor" 401(k) plans. The Notice should be favorably received by plan sponsors and practitioners as it provides some flexibility to amend a safe harbor 401(k) plan after the beginning of the plan year and retain safe harbor status. While the Notice is good news, it does not address important mid-year amendment issues that are specific to corporate mergers and acquisitions.

Background — Mid-Year Amendment Dilemma for Safe Harbor Plans

Congress amended Section 401(k) of the Internal Revenue Code (the "Code") in 1996 to add the original safe harbor 401(k) plan (the "Traditional Safe Harbor Plan") and then again in 2002 to add the qualified automatic enrollment safe harbor 401(k) plan (the "QACA" and together with the Traditional Safe Harbor Plan, the "Safe Harbor Plan"). A Safe Harbor Plan is deemed to satisfy certain requirements that the plan not discriminate in favor of highly compensated employees — the actual deferral percentage test ("ADP test") and, if the plan provides safe harbor matching contributions, the actual contribution percentage test ("ACP test"), with respect to those matching contributions.

Among other requirements, a Safe Harbor Plan must be maintained for the entire 12-month plan year for which it was adopted. Prior to the Notice, Treasury regulations were issued that permit mid-year amendments to a Safe Harbor Plan in two circumstances:

  • A plan termination before the end of the plan year;
  • A mid-year reduction or elimination of the safe harbor matching contribution or safe harbor non-elective contribution (as applicable, the safe harbor contribution if the employer (i) is operating at an economic loss or (ii) stated in the most recent annual safe harbor notice that the plan could be amended during the plan year to reduce or suspend the safe harbor contribution.

In either case, however, the plan would lose safe harbor status, thereby requiring ADP testing and, if applicable, ACP testing for the entire plan year. Outside of the Treasury regulations, the Service has issued formal guidance permitting mid-year amendments in very limited situations (such as, for example, Notice 2014-37, which permitted a mid-year amendment to comply with the United States Supreme Court's ruling on same-sex marriages in United States v. Windsor).

Thus, before the Notice it was unclear which mid-year changes to a Safe Harbor Plan could be made if the change was not one that was expressly permitted by the Service either in the regulations or formal guidance. This lack of certainty presented challenges for plan sponsors who want to make changes to their Safe Harbor Plan after the beginning of the plan year that are not expressly permitted by the Service. For example, would a change in the trustee, a change of investment options or a change from one prototype plan to another due to a change in third party administrators result in an impermissible mid-year amendment to the Safe Harbor Plan?

If the plan sponsor is wrong, the consequences can be severe. Adoption of an impermissible mid-year amendment to a Safe Harbor Plan would cause not only the loss of safe harbor status, but potentially loss of qualified plan status.

New Guidance — Mid-Year Amendments Under Notice 2016-16

Under the Notice, a Safe Harbor Plan may be amended mid-year — that is a change effective or adopted after the first day of the plan year — and continue to have safe harbor status, if:

  • Certain notice and election opportunity conditions are satisfied (only required if the change is to the annual safe harbor notice content required to be provided under the Treasury regulations) (the "required safe harbor notice content"); and
  • The change is not a prohibited mid-year change under the Notice (as described below).

If the mid-year amendment results in a change to the required safe harbor notice content, then an updated safe harbor notice describing the mid-year change and its effective date must be provided to the plan participants within a reasonable period before the effective date of the change. Under the Notice, providing the updated notice of the change not less than 30 days or more than 90 days before the effective date of the change is deemed to be a reasonable period. If the change is retroactive to the first day of the plan year, such as a mid-year amendment increasing the safe harbor contribution, the updated notice must be provided as soon as practicable, but not later than 30 days after the date the change is adopted. (If the information about the mid-year change and its effective date was provided in the annual safe harbor notice provided prior to the beginning of the plan year, no updated notice is required.)

If an updated safe harbor notice is required (as described above), employees must be given a reasonable opportunity (including a reasonable period after receipt of the updated notice) before the effective date of the amendment to change their pre-tax deferral and/or after-tax contribution elections. A 30-day election period is deemed a reasonable opportunity. If the change is retroactive, the election opportunity must begin as soon as practicable after the date the updated notice is provided, but not later than 30 days after the date the change is adopted.

The Notice makes clear that if the mid-year amendment does not change any of the required safe harbor notice content in the safe harbor notice, then the updated notice and election opportunity requirements do not apply, even if the change impacts non-required information that is included in the safe harbor notice.

Prohibited Mid-Year Amendments under the Notice. The Notice works in concert with the Treasury regulations. Thus, mid-year changes that are already addressed in the regulations, such as the reduction or elimination of the safe harbor contribution, must comply with the requirements of the regulations and cannot rely on the Notice. The Notice also cautions that other applicable laws, such as the anti-cutback restrictions under Section 411(d)(6) of the Code, may affect the ability of a plan sponsor to make a mid-year amendment. In addition, except as otherwise may be required by law, the Notice lists four mid-year changes that are never permitted;

  1. Increasing the vesting requirements for safe harbor contributions under a QACA;
  2. Reducing the number or otherwise narrowing the group of employees eligible to receive safe harbor contributions, unless it is an otherwise permissible change under eligibility service crediting rules or entry date rules for employees who are not eligible for the safe harbor contribution as of the date the change is effective or adopted;
  3. Changing the type of Safe Harbor Plan, such as changing from a Traditional Safe Harbor Plan to a QACA; and
  4. Modifying or adding a formula used to determine matching contributions (or the definition of compensation used to determine matching contributions) to increase the amount of matching contributions or permitting discretionary matching contributionsunless (i) the change is made at least 3 months prior to the end of the plan year, (ii) the updated notice and election opportunity requirements described above are met, and (iii) the change is retroactive for the entire plan year (which may require amending the plan to make the matching contributions based on the entire plan year, which may result in "true-up" contributions for active employees and employees that terminated during that plan year).

The Notice provides seven helpful examples on the application of the mid-year amendment rules.

Mid-Year Amendments and Corporate Mergers and Acquisitions

The Notice does not address mid-year amendment issues specific to corporate mergers and acquisitions, including the ability to merge two separate Safe Harbor Plans with the surviving plan retaining safe harbor status. The Service has requested comments on additional guidance that may be needed with respect to mid-year amendments to Safe Harbor Plans in the context of a merger or acquisition. For now, however, despite the flexible guidance provided in the Notice, it appears very likely that practitioners will not be comfortable merging Safe Harbor Plans mid year in most merger and acquisition situations until the Service issues additional guidance in this area.

For more on the merger and acquisition issues, the mid-year amendment issue and its background, please see “Mid-Year Amendments to Safe Harbor Plans After Notice 2016-16."