On May 18, 2009, the Internal Revenue Service issued proposed regulations allowing employers who incur a substantial business hardship to reduce or suspend safe harbor nonelective contributions under their 401(k) or 403(b) plan after the beginning of a plan year. Safe harbor nonelective contributions are contributions that employers may make on behalf of their nonhighly compensated employees, irrespective of whether such employees make any elective deferrals, to avoid the nondiscrimination tests that otherwise apply to qualified plans. Prior to the issuance of the proposed regulations, the only option available to employers who wanted to reduce or suspend their safe harbor nonelective contributions mid-year was plan termination. Employers may now rely on the proposed regulations for any mid-year reduction or suspension adopted after May 18, 2009, pending the issuance of final regulations. To the extent that any provisions in the final regulations are more restrictive than in the proposed regulations, such provisions will apply on a prospective basis only.


Plans maintained under Sections 401(k) and 403(b) of the Internal Revenue Code of 1986, as amended (the “Code”), must satisfy certain nondiscrimination requirements to maintain their tax-qualified status. Employers may meet these requirements by designing a plan that satisfies the conditions of a safe harbor provided for under the Code. A safe harbor plan is treated as satisfying the actual deferral percentage (“ADP”) and, if applicable, the actual contribution percentage (“ACP”) tests, which are the nondiscrimination tests that apply to employee deferrals and employer matching contributions, respectively. To qualify as a safe harbor plan, the plan must provide specified levels of nonelective contributions or matching contributions for nonhighly compensated employees. Nonelective contributions are employer contributions that are not based on the amount of elective deferrals made by the employee, whereas matching contributions are employer contributions that are based on the amount of elective deferrals made by the employee.

Subject to certain exceptions, the safe harbor provisions of the plan must be adopted before the first day of the plan year and remain in effect for an entire 12-month plan year. However, an exception permits an employer, under certain circumstances, either to terminate a safe harbor plan or, if the plan provides safe harbor matching contributions, to suspend or reduce such matching contributions. Thus, prior to the proposed regulations, an employer could suspend or reduce its safe harbor matching contributions mid-year, but not its safe harbor nonelective contributions.

Proposed Regulations

The proposed regulations amend the regulations under Code Sections 401(k) and 401(m) by allowing for the mid-year reduction or suspension of safe harbor nonelective contributions, including those made under qualified automatic contribution arrangements, with respect to an employer that incurs a “substantial business hardship” and meets certain additional requirements. The substantial business hardship standard under the proposed regulations is comparable to the standard that applies to a request for a minimum funding waiver for a defined benefit plan under Code Section 412(c). However, whereas the minimum funding waiver rules require a prior determination by the IRS that the employer has experienced a substantial business hardship, the proposed regulations merely require employers to make their own determination as to the existence of a substantial business hardship (and to substantiate the bases for such determination in the event of an IRS examination). The factors that an employer should consider to determine whether or not it is suffering a substantial business hardship include, but are not limited to, the following:

  • whether or not the employer is operating at an economic loss;
  • whether or not there is substantial unemployment or underemployment in the trade or business and in the industry concerned;
  • whether or not the sales and profits in the industry concerned are depressed or declining; and whether or not it is reasonable to expect that the plan will be continued only if the nonelective contributions are reduced or suspended.

In addition to establishing substantial business hardship, an employer must satisfy the following conditions, which are the same conditions as those that apply for purposes of reducing or suspending safe harbor matching contributions:

  • Notice to Employees: All eligible employees must be given a notice of the reduction or suspension. The notice must explain (i) the consequences of the reduction or suspension, (ii) the procedures for changing employee elections and (iii) the effective date of the amendment.
  • Plan Amendment: The plan must be amended prior to the end of the plan year (see Effective Date below). The amendment must provide that the ADP test and/or ACP test, as applicable, will be satisfied for the entire plan year in which the reduction or suspension occurs, using the current year testing method.
  • Effective Date: The reduction or suspension must be effective no earlier than the later of 30 days after eligible employees are provided the notice and the date the amendment is adopted. The plan must satisfy the safe harbor nonelective contribution requirement with respect to safe harbor compensation paid through the effective date of the amendment.
  • Opportunity to Change Employee Elections: All eligible employees must be given a reasonable opportunity (including a reasonable period after receipt of the notice) prior to the reduction or suspension to change their cash or deferred elections and, if applicable, their employee contribution elections.

Consequences of a Reduction or Suspension

If a plan is amended during the plan year to reduce or suspend safe harbor nonelective contributions or matching contributions, it is no longer a plan that applies a safe harbor method for the entire plan year and will be subject to the top-heavy plan rules under Code Section 416. If the plan is considered a top-heavy plan, meaning that the value of the accrued benefits or account values for key employees is more than 60 percent of the value of accrued benefits or account values for all employees, then the employer is required to make certain minimum contributions for non-key employees. Thus, all or part of the benefit of eliminating the nonelective or matching contributions may be lost.

Further, if a plan is amended during the plan year to reduce or suspend safe harbor nonelective contributions or matching contributions, it must prorate the applicable Code Section 401(a)(17) compensation limit, which is US$245,000 for 2009, to reflect the shorter contribution period for the year of reduction or suspension. This may require employers to correct prior contributions if those contributions were based on compensation in excess of the prorated annual compensation limit.


The proposed regulations permitting a mid-year reduction or suspension of safe harbor nonelective contributions provide a viable alternative to terminating the plan for employers who have incurred a substantial business hardship.