Proposed Regulations Allow Suspension or Reduction of Safe Harbor Nonelective Contributions Mid-Year

IRS Proposes Rules Allowing Employers to Suspend or Reduce Safe Harbor Nonelective Contributions discusses the release of proposed Treasury Regulation [REG–115699–09] – Suspension or Reduction of Safe Harbor Nonelective Contributions effective for amendments adopted after May 18, 2009. The proposed regulations would permit an employer that incurs a substantial business hardship to reduce or suspend safe harbor nonelective contributions during a plan year, providing an alternative to terminating the safe harbor plan:

The proposed regulations would amend Sec. Sec. 1.401(k)-3 and 1.401(m)-3 to permit an employer sponsoring a safe harbor plan described in section 401(k)(12) or 401(k)(13) that incurs a substantial business hardship (comparable to a substantial business hardship described in section 412(c)) to reduce or suspend safe harbor nonelective contributions during a plan year. These proposed regulations would provide an employer an alternative to the option of terminating the employer's safe harbor plan in such a situation.

The proposed regulations would allow for the reduction or suspension of safe harbor nonelective contributions under rules generally comparable to the provisions relating to the reduction or suspension of safe harbor matching contributions. Under these rules, a plan that reduces or suspends safe harbor nonelective contributions will not fail to satisfy section 401(k)(3), provided that:

(1) All eligible employees are provided a supplemental notice of the reduction or suspension;

(2) the reduction or suspension of safe harbor nonelective contributions is effective no earlier than the later of 30 days after eligible employees are provided the supplemental notice and the date the amendment is adopted;

(3) eligible employees are given a reasonable opportunity (including a reasonable period after receipt of the supplemental notice) prior to the reduction or suspension of the safe harbor nonelective contributions to change their cash or deferred elections and, if applicable, their employee contribution elections;

(4) the plan is amended to provide that the ADP test will be satisfied for the entire plan year in which the reduction or suspension occurs, using the current year testing method; and

(5) the plan satisfies the safe harbor nonelective contribution requirement with respect to safe harbor compensation paid through the effective date of the amendment.

The proposed regulations would also provide that the supplemental notice requirement is satisfied if each eligible employee is given a notice that explains:

(1) The consequences of the amendment reducing or suspending future safe harbor nonelective contributions;

(2) the procedures for changing cash or deferred elections and, if applicable, employee contribution elections; and

(3) the effective date of the amendment.

The proposed regulations would further provide that these same rules that apply to safe harbor plans under Sec. 1.401(k)-3 also apply to safe harbor plans under Sec. 1.401(m)-3, except that the plan must be amended to provide that the ACP test will be satisfied for the entire plan year in which the reduction or suspension occurs using the current year testing method.

Because the reduction or suspension of safe harbor contributions can be effective no earlier than the later of 30 days after the notice is provided to all eligible employees and the date the amendment is adopted, an employer that wants to reduce or suspend safe harbor contributions during a year could not implement this change by adopting the amendment at the end of the plan year. In addition, a plan that is amended during the plan year to reduce or suspend safe harbor contributions (whether nonelective contributions or matching contributions) must prorate the otherwise applicable compensation limit under section 401(a)(17) in accordance with the requirements of Sec. 1.401(a)(17)-1(b)(3)(iii)(A). Furthermore, a plan that is amended to reduce or suspend safe harbor contributions is no longer a plan described in section 401(k)(12), 401(k)(13), 401(m)(11), or 401(m)(12) for the entire plan year. Accordingly, such a plan is not described in section 416(g)(4)(H) and, thus, will be subject to the top-heavy rules under section 416.

The regulations refer to IRC Section 412(c) for the definition of a substantial business hardship, which refers to IRC Section 412(d)(2) - Minimum funding standards - Variance from minimum funding standard - Determination of business hardship:

(2) Determination of business hardship

For purposes of this section, the factors taken into account in determining temporary substantial business hardship (substantial business hardship in the case of a multiemployer plan) shall include (but shall not be limited to) whether or not—

(A) the employer is operating at an economic loss,

(B) there is substantial unemployment or underemployment in the trade or business and in the industry concerned,

(C) the sales and profits of the industry concerned are depressed or declining, and

(D) it is reasonable to expect that the plan will be continued only if the waiver is granted.