NEWSLETTERS

IRS Proposed Regulations Allow Suspension or Reduction of Safe Harbor Nonelective Contributions

On May 18, 2009, the Internal Revenue Service (IRS) issued proposed regulations that allow plan sponsors of safe harbor 401(k) retirement plans that experience a substantial business hardship to suspend or reduce safe harbor nonelective contributions during the plan year.  Prior to these proposed regulations, safe harbor 401(k) plan sponsors making nonelective contributions could only terminate their plan to stop the nonelective contributions.

The proposed regulations are similar to existing regulations that allow sponsors of safe harbor matching plans to suspend or reduce matching contributions instead of terminating the plan.  They apply to both traditional safe harbor nonelective contributions and safe harbor nonelective contributions under qualified automatic contribution arrangements (QACAs).

The proposed regulations permit an employer that incurs a substantial business hardship to reduce or suspend the nonelective contribution during the plan year if they meet the following 5 requirements: (1) all eligible employees are provided a supplemental notice of the suspension or reduction; (2) the amendment is effective no earlier than the later of 30 days after the supplemental notice is distributed to all eligible employees or the date the amendment is adopted; (3) eligible employees are given a reasonable opportunity after the notice and prior to the reduction or suspension to change their employee contribution elections; (4) the plan is amended to provide that the ADP discrimination test using the current year testing method will apply for the entire year of the suspension or reduction; and (5) the plan satisfies the safe harbor nonelective contribution requirement through the amendment’s effective date.

The supplemental notice requirements are identical to the rules that currently apply when suspending or reducing a safe harbor match contribution.  The notice must explain the consequences of suspending the safe harbor contribution, the procedures by which an employee may change his or her deferral election and the effective date of the amendment.

The proposed regulations state that a substantial business hardship is described in Internal Revenue Code (IRC) section 412(c).  These substantial business hardship reasons are the same reasons that allow a pension plan funding deficiency waiver. Under this code section, a substantial business hardship includes, but is not limited to, whether or not: (1) the employer is operating at an economic loss; (2) there is substantial unemployment or underemployment in the employer’s trade or business; and (3) the sales and profits of the employer’s industry are depressed or declining.

Plan sponsors may rely on these proposed regulations immediately.  If more restrictive regulations are adopted in the future, they will not be applied retroactively.

These proposed regulations will provide relief to some plan sponsors in these tough economic times.  They won’t necessarily help top-heavy plan sponsors since suspending or reducing a safe harbor nonelective contribution will require compliance with top-heavy contribution rules in addition to the ADP discrimination testing rules. 

A plan which is amended to suspend either the safe harbor nonelective or the safe harbor matching contributions must prorate the section 401(a)(17) compensation limit for the year (see “How the Annual Compensation Limit Affects your Contribution Calculation” article for information about this limit).  For example, if a plan suspends a safe harbor 3% nonelective contributions on July 1, 2009 (6 months after the plan year starts), then the 2009 section 401(a)(17) limit of $245,000 would be prorated to $122,500 (prorated 6 months) and no employee could receive a safe harbor 3% nonelective contribution in excess of $3,675 ($122,500 x 3%) for the year, regardless of whether the employee earned more than $122,500 for that portion of the plan year. 

Plan sponsors that utilize safe harbor nonelective contributions may consider using the safe harbor maybe provisions for the next plan year.  The safe harbor maybe provisions allows the plan sponsor the flexibility of not contributing the safe harbor nonelective contribution to the participants simply by providing a notice 30 days prior to year end stating that the plan will not be contributing the safe harbor nonelective contribution for that year.  With safe harbor maybe provisions, if the safe harbor contribution is not made, the plan is not safe harbor for that given year and the plan is therefore subject to the top-heavy rules and the ADP discrimination testing rules.  If the plan is top-heavy for a plan year, key employees (offices and owners) should not make 401(k) contributions until the plan sponsor knows whether it can afford the safe harbor nonelective contribution. 

Due to the economy,  proper planning is paramount to the success of your retirement plan.  In October of 2008, Administrative Retirement Services, Inc. (ARS) envisioned potential economic challenges and contacted our clients with safe harbor provisions in their plans via mail to inform them of the various safe harbor contribution rules so changes could be made prior the start of the 2009 plan year if need be.  ARS will continue to inform you of changes to the law, and long standing rules, that may be beneficial to your plan.

If you have any questions about safe harbor nonelective, safe harbor match, or safe harbor maybe, please contact Administrative Retirement Services, Inc.

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