Summer 2009
Employers Facing Business Hardship May Halt 401(k) and 403(b) Safe Harbor Nonelective Contributions
On May 18, 2009, the IRS issued proposed regulations allowing employers experiencing substantial business hardship to reduce or suspend safe harbor contributions mid-year for plans under IRC § 401(k)(12) and Qualified Automatic Contribution Arrangements (QACAs) under IRC § 401(k)(13).
The proposed regulations allow nonelective safe harbor contributions to be suspended mid-year under certain conditions without terminating the plan.
Following are answers to several commonly asked questions.
Can an employer stop making safe harbor nonelective contributions mid-year?
Yes, in some circumstances. However, nonelective safe harbor contributions must be deposited to the plan based on compensation earned up to the effective date of discontinuance.
Can an employer stop or reduce safe harbor matching contributions mid-year?
Yes, current regulations permit employers to amend plans to suspend safe harbor matching contributions. However, safe harbor matching contributions must be deposited to the plan based on deferrals made up to the effective date of discontinuance.
What is a substantial business hardship?
In this instance, the IRS defines a substantial business hardship as “comparable” to a substantial business hardship under IRC § 412(c). This definition takes into account the following factors (others may be considered as well):
- The business is operating at an economic loss.
- Substantial unemployment or underemployment exists in the trade or business and in the industry concerned.
- Sales and profits of the industry are depressed or declining.
- It is reasonable to expect that the plan will be continued only if the safe harbor is eliminated.
How can we be certain the IRS will honor an employer’s determination that a substantial business hardship exists?
There are no guarantees and we are unable to make the determination for you. Employers that cannot demonstrate reasonable reliance on the factors cited should not use the proposed regulations to eliminate safe harbor nonelective contributions. If uncertain, you should consult with your attorney.
What are the requirements for reducing or suspending 401(k) safe harbor contributions?
- A 30-day “supplemental” notice is required. The effective date of the plan amendment must be at least 30 days after notice to eligible employees of the contribution reduction or suspension. The notice must explain the reduction or suspension of future safe harbor contributions and its consequences, the procedures for changing employee elections and the effective date.
- A plan amendment is required. An employer must amend the plan to provide for the reduction or suspension of safe harbor contributions.
- Employees must be given time to change elections. Eligible employees must be given a reasonable period of time after they receive the supplemental notice (but prior to the reduction or suspension of the safe harbor contributions) to change their salary deferral elections.
- ADP/ACP testing requirements apply for the entire year. The plan amendment must provide that the plan will satisfy the actual deferral percentage (ADP) test and the average contribution percentage (ACP) test, if applicable, for the entire plan year.
- Suspension or reduction of contributions may be prospective only. Safe harbor contributions must be deposited to the plan based on the participant's compensation paid up to the later of the date the amendment is adopted or 30 days after eligible employees are provided the supplemental notice. The plan must also prorate the § 401(a)(17) maximum compensation limit, although how this would work in practice has not been clarified.
- The plan cannot rely upon the safe harbor nonelective contribution for this year to satisfy the Top-Heavy Test.
Are there other steps an employer may take short of reducing or suspending safe harbor nonelective contributions?
Yes. For example, if the employer is experiencing financial difficulties and believes it cannot make the 3 percent safe harbor nonelective contribution, it can delay making the contribution at least until the due date for deduction purposes. If the plan specifies the contribution will be made sooner (for example, per payroll period), then an amendment may be necessary to allow the delay.
Under certain circumstances, on a case-by-case basis, it may be feasible to delay depositing the nonelective contribution for up to 12 months after the close of the year.
In extreme circumstances, the employer may consider terminating the plan to eliminate further accruals. However, since this means the employer will be without a replacement plan for at least 12 months, employers exploring this option should seek the assistance of ERISA counsel.
If you have questions about a specific case, consult your account manager or client service consultant at The Standard.
