On May 18, 2009, the Internal Revenue Service (IRS) issued proposed regulations that would permit employers experiencing a substantial business hardship to suspend or reduce safe harbor nonelective contributions under a 401(k), 401(m) or 403(b) plan during a plan year. The regulations are intended to provide employers experiencing a significant economic downturn with an alternative to plan termination.

The proposed regulations, which can be found here, are effective for plan amendments adopted after May 18, 2009. Employers may rely on the proposed rules now, pending the issuance of final regulations. Comments on the proposed regulations are due by August 17, 2009.

Background

Plans maintained under Internal Revenue Code (IRC) § 401(k) and § 401(m) and certain contributions under IRC § 403(b) plans must meet certain nondiscrimination and other requirements to maintain their tax-favored status. This usually requires yearly testing to establish that the benefits provided under the plan do not discriminate disproportionately in favor of highly compensated employees. These tests are often referred to as the “ADP test” and the “ACP test.” Plans that meet certain safe harbor requirements, however, are not required to perform these nondiscrimination tests. To satisfy the IRC’s nondiscrimination safe harbors, an employer must, among other requirements, make either safe harbor matching or safe harbor nonelective contributions to the plan each year on behalf of its non-highly compensated employees. Generally, an employer must adopt a safe harbor for its plan before the plan year begins and make these safe harbor contributions for the entire year, although there are some exceptions to this rule. For example, an employer may, during the plan year, terminate a safe harbor plan or suspend or reduce safe harbor matching contributions if certain requirements are met. Before the IRS issued these proposed regulations, however, employers making safe harbor nonelective contributions were not able to suspend or reduce those contributions during a plan year.

Summary of Proposed Guidance

The proposed regulations are similar to the existing rules permitting the suspension or reduction of safe harbor matching contributions during a plan year. The proposed rules would allow a safe harbor plan to be amended to suspend or reduce safe harbor nonelective contributions during a plan year if:

  • The employer incurs a “substantial business hardship” (as described below);
  • The amendment is adopted after May 18, 2009;
  • Eligible employees are given a supplemental notice describing the suspension or reduction;
  • The suspension or reduction becomes effective no earlier than the later of 30 days after the supplemental notice is provided and the date the amendment is adopted;
  • Eligible employees are given a reasonable opportunity and period of time before the suspension or reduction takes effect to adjust their pre-tax deferral elections and employee contributions, if applicable;
  • The plan is amended to provide that it will satisfy the ADP test and/or the ACP test, using the current year testing method, for the full plan year; and
  • The plan satisfies the safe harbor nonelective contribution requirement with respect to compensation paid through the amendment’s effective date.

The supplemental notice requirement will be deemed satisfied if all eligible employees are provided with a notice that describes (1) the consequences of the amendment suspending or reducing safe harbor nonelective contributions; (2) the procedures for adjusting the employee’s pre-tax deferral elections and employee contributions, if applicable; and (3) the amendment’s effective date.

Under the proposed regulations, a “substantial business hardship” is comparable to a substantial business hardship under the IRC § 412(c) funding rules. The factors used under IRC § 412 to determine whether an employer has suffered a “substantial business hardship” include, but are not limited to: (1) whether the employer is operating at an economic loss; (2) whether there is substantial unemployment or underemployment in the employer’s trade or business; (3) whether the sales and profits of the employer’s industry are depressed or declining; and (4) whether it is reasonable to expect that the plan will be continued only if relief is granted.

Additional Guidance Regarding Suspensions or Reductions of Safe Harbor Contributions

The IRS notes in the preamble to the proposed regulations that because a suspension or reduction of safe harbor nonelective contributions cannot take effect before the later of 30 days after the notice is provided to employees and the date the amendment is adopted, a suspension or reduction cannot be accomplished by adopting an amendment at the end of a plan year. Additionally, a plan implementing a suspension or reduction of safe harbor nonelective contributions during the year must prorate the compensation limit under IRC §401(a)(17). Finally, a plan implementing a suspension or reduction of safe harbor nonelective contributions is no longer a safe harbor plan for the entire plan year and thus will be subject to the top-heavy rules under IRC § 416.

Potential Addition to Safe Harbor Notice Requirements

In connection with the safe harbor matching and nonelective contribution relief, the IRS is considering requiring that the annual safe harbor notice to participants describe the possibility that safe harbor matching or nonelective contributions may be suspended or reduced during the plan year. The IRS has requested comments on whether this content requirement, which would not be effective for plan years beginning before January 1, 2010, should be added to the regulations governing the annual safe harbor notice.