The general rule for employer safe harbor elections is that they must be in place for a 12 month period. However, under the final code section 401(k) regulations, 401(k) profit sharing plans adopting a safe harbor design with a guaranteed matching contribution are allowed to suspend the safe harbor if the Plan Sponsor: (1) provides a 30 day advance notice; (2) formally amends the plan to freeze the match; and (3) applies non-discrimination tests for the entire plan year. No particular reason is required under the rinal regulations to suspend safe harbor match.
Due to economic pressures, many plan sponsors that adopted the 401(k) safe harbor plan design with the 3% non-elective (profit sharing) contribution have sought similar relief. However, under existing regulations, the only way for these plans to avoid the 12-month rule is to terminate the plan. Termination of the plan triggers full vesting on all profit sharing and other non-safe harbor contributions and unless the termination is due to severe business hardship or is a result of a merger or similar transaction, discrimination testing is required for the year of termination.
Many plan sponsors and practitioners have commented to the IRS that it is inequitable to require a plan termination for a safe harbor plan using the non-elective contributions when mid-year suspension was allowed for safe harbor matching contributions.
In response, the IRS issued proposed regulations that are immediately effective, which will now allow a mid-year suspension of 401(k) safe harbor non-elective contributions when certain requirements are met. First, to avoid a plan termination and implement a mid-year suspension of the 401(k) safe harbor non-elective contributions, the employer must demonstrate that it is experiencing a “substantial business hardship.” Under the proposed regulations, the criteria to be applied is similar to that described in Internal Revenue Code § 412(c) when applying for minimum funding waivers under a pension plan. These include: (1) the employer is operating at an economic loss; (2) there is substantial unemployment or underemployment in the employer’s trade or business; and (3) sales and profits of the employer’s industry are depressed or declining. The IRS suggests that employers retain objective trade reports and financial statements in the event of a later IRS audit to demonstrate compliance with these requirements.
Additional requirements to suspend contributions include the following: (1) the employer must formally amend the plan before the suspension can take effect; (2) eligible employees must receive a supplemental notice at least 30 days before the effective date of the amendment; (3) employees must have a reasonable opportunity after receipt of the notice to suspend or change their deferral elections; (4) the employer must fund and satisfy the safe harbor non-elective contribution requirement through the effective date of the amendment; and (5) the employer must apply the 401(k) nondiscrimination tests for the entire plan year using the current year method.
Employers relying on safe harbor status to avoid making a 3% minimum top-heavy contribution to non-key employees will be required to make that contribution for the entire plan year. The supplemental notice must explain the consequences of the amendment, the procedures for changing deferral elections and the effective date of the amendment.
Employers contemplating a suspension of their safe harbor non-elective contributions may wish to consult benefits counsel to ensure that they meet all requirements for that suspension.