Last Friday, the IRS provided guidance on ways for employers to reduce or eliminate the employer contribution to a safe harbor 401(k) plan mid-year, guidance which employers looking to enhance their bottom lines will welcome with open arms. For employers who satisfy the employer contribution requirement of their safe harbor 401(k) plan through nonelective contributions, these new rules provide some additional flexibility and may warrant changes to the annual safe harbor notice for the 2014 plan year.
Many 401(k) plan sponsors adopt a safe harbor plan design to avoid annual 401(k) ADP/ACP nondiscrimination testing. In addition to annual notice requirements, employers that adopt a safe harbor design must commit (before the beginning of the next plan year) to either contribute a set percentage of each eligible employee’s compensation to the plan (a nonelective contribution) or to match eligible employees’ contributions to the plan at a set rate, as approved by the IRS (often 100% of the first 3% of compensation and 50% of the next 2%). An employer’s election to adopt a safe harbor design for the plan year is, generally, irrevocable.
Historically, the IRS has provided some flexibility to employers wishing to reduce or suspend employer contributions under their safe harbor 401(k) plans in the middle of the year. However, under proposed regulations issued in 2009, for employers satisfying the safe harbor contribution requirement through nonelective contributions, those requirements were significantly limiting in that they required an employer to have incurred a “substantial business hardship.” While the new regulations change this requirement to require proof of “economic loss,” which the IRS believes will be less burdensome, they also provide an entirely new option that allows employers to reduce or suspend nonelective contributions without regard to the employer’s financial condition.
In lieu of having an “economic loss,” the employer may simply include a statement in its annual safe harbor notice that “discloses the possibility that the contributions might be reduced or suspended mid-year.” This new method calls to mind the contingent safe harbor design already permitted under the Internal Revenue Code, but provides the reverse option for employers. Whereas in a contingent safe harbor design, the plan starts the plan year as a ADP/ACP tested plan having notified employees that it reserves the right to convert to a safe harbor design by the end of the year, under these new rules, a 401(k) plan would start the plan year as a safe harbor plan but reserve the right to revoke its safe harbor status during the plan year and submit to nondiscrimination testing for that year. Plans that satisfy the safe harbor contribution requirement through matching contributions must now also include the reduction or suspension information in the safe harbor notice (or meet the economic loss standard) in order to reduce or suspend matching contributions mid-year.
In addition to the initial notice requirement (or, alternatively, satisfaction of the economic loss standard), employers wishing to reduce or suspend safe harbor employer matching or nonelective contributions mid-year must also:
- provide eligible employees with a supplemental notice, once it has been decided that contributions will be reduced or suspended, that explains the consequences of the reduction or suspension, the procedures for changing their elections for plan contributions and the effective date of the change;
- amend the plan to provide for the reduction or suspension;
- wait to implement the reduction or suspension until at least 30 days after the supplemental notice is provided or the date the plan is amended to account for the change, if later;
- give eligible employees a “reasonable opportunity” prior to the reduction or suspension to change their elections;
- ensure the plan passes nondiscrimination testing for the entire year (not just for the period after the change) under the current year testing method; and
- pay any nonelective and/or matching contributions promised under the terms of the plan prior to its amendment.
This new “notice” option provides an interesting planning opportunity for sponsors of safe harbor 401(k) plans; namely, that employers could add language to their annual safe harbor notices as a matter of course reserving the right to reduce or suspend employer matching or nonelective safe harbor contributions at any point in the year. Providing this language in the safe harbor notice, which already must be prepared and distributed annually, would be a minimal burden with the substantial upside of allowing mid-year changes to employer safe harbor contributions. While the reduction or suspension notice for a plan satisfying the safe harbor requirements through nonelective contributions can be included in the safe harbor notice for the 2014 plan year, employers will have to wait until the plan year 2015 notice to include information on reductions or suspensions in matching contributions.
These final rules provide some additional options for 401(k) plan sponsors, and our employee benefits attorneys are available to talk through any particular issues or questions you may have in processing or implementing these new rules.