In our employee benefits practice, we continue to see the impact the economy is having on our clients. While there are signs that the economy is starting to slowly recover, our clients still come to us with liquidity issues. A common question is whether the employer can stop making contributions to their 401(k) plan, especially safe harbor matching and safe harbor nonelective contributions. The issue of suspending safe harbor contributions is difficult because the employer is required to commit to making them before the beginning of the plan year in order to avoid having to perform the normal 401(k) nondiscrimination testing.
In Part I of this article, we discussed how a plan sponsor could reduce and/or suspend safe harbor matching contributions, that is, the commitment to match the deferrals of participating employees up to a specified percentage of pay. At the time, the Treasury Regulations did not provide for the reduction and/or suspension of safe harbor nonelective contributions (i.e., the commitment on the part of the employer to make a contribution for all eligible employees, regardless of whether they defer into the 401(k) plan). The only way to effectively stop such contributions mid-year was to terminate the plan, which many employers did not want to do. However, on May 18, 2009, proposed regulations were issued that permit the reduction and/ or suspension of safe harbor nonelective contributions. The proposed regulation specifically states that plan sponsors may rely on a good faith interpretation of the rules even though they are not yet final.
In recognizing the need for such relief, the IRS stated in the Special Analyses to the proposed regulations that “…adopting the provisions in these regulation [sic] will in almost all cases save the small business owner money.” The new proposed regulations will allow a plan sponsor to amend their safe harbor 401(k) plan to reduce and/or suspend qualified non-elective contributions during the plan year, and not be forced to terminate the plan.
To be a “safe harbor” plan, and thus avoid performing nondiscrimination testing, the plan must meet a number of requirements, including a contribution by the plan sponsor of either a fully vested match or a fully vested nonelective (or profit sharing) contribution 3% of an eligible employee’s compensation (regardless of whether the employee makes deferrals). The proposed regulation allows plan sponsors to reduce and/or suspend these nonelective contributions on a prospective basis, but to do so, the employer must comply with the following rules:
- The plan must be amended to provide that it must satisfy both the ADP and ACP tests for the entire plan year using the current year testing method, regardless of the fact that safe harbor contributions were made for part of the year;
- All safe harbor contributions must be made up until the effective date of the amendment with respect to all deferrals made to that time;
- The reduction or suspension of the nonelective safe harbor contribution may not be effective earlier than 30 days after delivery to the eligible employees of a notice containing the information described below (or 30 days after the amendment is adopted, whichever is later);
- Eligible employees must be given a reasonable opportunity to change their existing deferral elections after receipt of the notice, but prior to the effective date of the amendment;
- The notice to eligible employees must contain an explanation of the following:
i) the consequences of the amendments reducing or suspending future safe harbor nonelective contributions;
ii) the procedures for changing the employee’s deferral election and, if applicable, employee contribution elections; and
iii) the effective date of the amendment to the plan which suspends and/or reduces the nonelective safe harbor contribution.
Now that the IRS has provided for the reduction and/or suspension of the safe harbor nonelective contribution, plan sponsors may be able to avoid terminating their plans and continue to provide retirement benefits to their employees. This relief should also continue to help plan sponsors with liquidity issues as the economy begins to recover.
Disclaimer Required by IRS Rules of Practice:
Any discussion of tax matters contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding any penalties that may be imposed under Federal tax laws.