IRS Allows Safe Harbor Plans to Suspend Nonelective Contributions

Summary – The IRS published a proposed rule to allow 401(k) plan sponsors experiencing a ‘substantial business hardship” to reduce, suspend, or eliminate “safe harbor” non elective contributions during a plan year under rules similar to those already in place for safe harbor matching contributions. By doing so, however, they must give up their plans’ safe harbor status. Absent this new relief, an employer’s only recourse to reduce or stop safe harbor nonelective contributions mid-year is to terminate the plan.

The proposed rule, which sponsors may rely on pending the issuance of a final rule is effective for amendments adopted after May 18, 2009, and presents an alternative to plan termination during the current economic environment. The proposed rule has most relevance to 401(k) plan, which are the primary focus of this bulletin.

Discussion – A 401(k) plan may circumvent some of the otherwise applicable nondiscrimination tests by means of a safe harbor plan design. Among other requirements, such a design obligates the plan sponsor to make either safe harbor matching or nonelective contributions on behalf of nonhighly compensated employees. Unlike in the case of matching contributions (which are made to eligible participants based on the amounts they elect to defer), a plan sponsor must provide nonelective contributions across the board to all eligible employees, irrespective of whether they make elective deferrals. To satisfy the safe harbor nonelective contribution requirement, plans must provide qualified nonelective contributions to at least 3% of safe harbor compensation.

Prior to issuance of the proposed rule, safe harbor plans were not allowed to reduce, suspend, or eliminate employer nonelective contributions during the plan year, except by discontinuing the plan entirely. To keep the plan going, the plan sponsor would have to make such a change before the start of the next plan year. In contrast, a safe harbor plan sponsor may reduce, suspend, or eliminate the matching contributions mid-year. The IRS’s new proposed rule extends this option applicable to company matching contributions to nonelective contributions, if certain conditions are satisfied.

Proposed Guidance

Under the proposed rule, a plan sponsor that reduces, suspends, or eliminates safe harbor nonelective contributions must satisfy certain requirements, which include:
• amending the plan to provide that, using the current year testing method, the applicable nondiscrimination tests will be satisfied for the entire plan year in which the reduction/suspension/elimination occurs;
• providing advance notice to participants;
• having an effective date for the reduction/suspension/elimination that is at least 30 days after providing the participant notice or, if later, the amendment adoption date;
• affording participants a reasonable opportunity to change their salary deferral elections prior to the reduction/suspension/elimination;
• maintaining compliance with the safe harbor nonelective contribution requirement (i.e., safe harbor nonelective contributions must continue to be paid up to the amendment’s effective date); and
• limiting safe harbor compensation to a prorated amount of the $245000 (2009) annual limit, reflecting the shortened safe harbor contribution period.

Notice to Participants

The plan sponsor must provide a notice to employees. This notice must explain the consequences of the plan amendment reducing, suspending, or eliminating the nonelective contribution. It must explain the procedures that an employee must follow to change his or her salary deferral election. And it must include the date that the amendment becomes effective.

Substantial Business Hardship

For an employer to be able to take advantage of the relief available, it must experience a substantial business hardship. According to the IRS, criteria for determining whether a company is suffering a “substantial business hardship” include, but are not limited to, the fact that:
• The employer is operating at a loss economically;
• The employer’s trade or business, as well as its industry, is experiencing substantial unemployment or under employment; and
• Sales and profits for the industry in general are declining or depressed.

Nondiscrimination Testing

One of the main reasons employers choose to adopt safe harbor plans is to simplify or eliminate the complexities of non discrimination testing. By reducing or suspending the plan’s nonelective contribution, the plan gives up its safe harbor status, which brings the relevant nondiscrimination rules back into force.

Thus, safe harbor plan sponsors seeking relief will have to perform the actual deferral percentage (ADP) non-discrimination test on employee elective deferrals and the “top heavy” test to ensure that the plan does not disproportionately favor highly compensated employees and key employees, respectively. Because safe harbor nonelective contributions qualify as “qualified nonelective contributions” (QNECs), they may be included with employee 401(k) elective deferrals in satisfying the ADP nondiscrimination test for a year in which safe harbor nonelective contributions are reduced, suspended, or eliminated.

If the plan also includes matching contributions and/or employee after-tax contributions, the actual contribution percentage (ACP) test will also apply. (Note that even plans that satisfy the safe harbor criteria to avoid ADP testing (the “ADP safe harbor”) do not always meet the safe harbor criteria to avoid the ACP test (the “ACP safe harbor”). Additionally, employee after-tax contributions do not escape being subject to the ACP test, even if the plan includes a matching contribution that meets the ACP safe harbor).

Action – Before a plan sponsor decides whether to reduce, suspend, or eliminate the nonelective contribution to its safe harbor plan, it will need to determine whether its business is experiencing what the IRS defines as a “substantial business hardship.” If the plan sponsor can substantiate such a claim, then it must decide whether this is the appropriate step to take. Plan sponsors should consult with their attorneys, accountants, defined contribution plan consultants, and other professional advisors before proceeding. If such a change is made, the employer will have to modify administrative and payroll procedures, as well as modify relevant communications materials.


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