On November 15, 2013, the Internal Revenue Service issued final regulations on mid-year reductions or suspensions of “safe harbor” contributions made to 401(k) plans under Internal Revenue Code (“Code”) Section 401(m)(13). The final regulations revised the proposed regulations, issued May 8, 2009.
Under applicable regulations, 401(k) plans are usually subject to numeric nondiscrimination testing rules (commonly known as the actual deferral percentage (ADP) and actual contribution percentage (ACP) tests) that limit the amount of contributions made on behalf of highly compensated employees in proportion to the amount of contributions made for non-highly compensated employees. If the nondiscrimination testing limits are exceeded, contributions for highly compensated employees must be reduced or cut back. Plan sponsors may, however, avoid the burdens of numeric testing by (1) adopting a design-based safe harbor contribution formula providing a minimum level of matching or non-elective employer contributions to non-highly compensated employees, and (2) by satisfying certain notice requirements. If the safe harbor plan is adopted before the beginning of the plan year and maintained for the full 12 months of the plan year, it is not necessary to limit, reduce or cut back contributions made on behalf of highly compensated employees as might otherwise be required under the ADP and ACP tests.
Prior to the final regulations, plan sponsors could reduce or suspend safe harbor matching contributions mid-year (subject to certain notice and timing requirements) by amending the plan and actually satisfying the numeric non-discrimination testing under the current year testing method. By contrast, plan sponsors could reduce or suspend safe harbor non-elective employer contributions mid-year only on account of substantial business hardship (similar to the definition in Code section 412(c)(2)).
In other words, prior to the final regulations, plan sponsors could reduce or suspend safe harbor non-elective employer contributions mid-year only on account of substantial business hardship, while safe harbor matching contributions could be reduced or suspended mid-year without any showing of substantial business hardship.
The final regulations eliminate the difference in requirements for mid-year suspensions or reductions of safe harbor matching contributions and safe harbor non-elective contributions by providing a uniform standard, albeit with different effective dates. Effective November 15, 2013, non-elective employer contributions may be reduced or suspended mid-year, provided either that (1) the plan sponsor shows that it is operating at an economic loss; or (2) the plan’s safe harbor notice (or contingent notice) for the year in which the reduction or suspension occurs states:
- The Plan may be amended mid-year to reduce or suspend the safe harbor contribution,
- A supplemental notice will be provided if reduction or suspension occurs, and
- No reduction or suspension will take effect until at least 30 days after the supplemental notice is provided.
Effective for plan years commencing on or after January 1, 2015, the same standard will apply to mid-year reductions or suspensions of safe harbor matching contributions. The later effective date takes into account the new standard now applicable for safe-harbor matching contributions.
New Economic Loss Standard
The new “economic loss” standard differs significantly from the old “substantial business hardship” standard previously applicable only to safe harbor non-elective contributions. The “substantial business hardship” standard required the plan sponsor not only to determine its own financial health, but to determine the health of the industry (as described in Code section 412(c)(2)(B) and (C)). The old standard also required a determination that the reduction or suspension of safe harbor non-elective contributions was necessary for the plan to continue (as in Code section 412(c)(2)(D)). The new “economic loss” standard should be easier to meet because it eliminates both of these requirements.
In lieu of satisfying the “economic loss” standard, the plan administrator may provide a mid-year supplemental notice (i) explaining the consequences of any Plan amendment that reduces or suspends the safe harbor contributions mid-year, (ii) the procedures for changing salary deferral elections, and (iii) the effective date of the reduction or suspension. The plan administrator must then give employees a reasonable opportunity of not less than 30 days after the supplemental notice is provided and before the reduction or suspension occurs to change their salary deferral elections.
In the event of a mid-year reduction or suspension of matching or non-elective employer contributions, the 401(k) plan must be tested using the current-year testing method for the entire plan year in which the reduction or suspension occurs.
Safe harbor notices provided in 2013 may need to be revised to preserve the option of reducing or suspending safe harbor non-elective contributions in 2014, without having to make a showing of economic loss. Safe harbor notices provided in 2014 may also need to be revised to preserve the option to suspend or reduce all safe harbor contributions in 2015 without having to make a showing of economic losses.