IRS Final Regulations on Suspending Safe Harbor Contributions During the Plan Year
January 07, 2014
The Internal Revenue Service (IRS) recently published final regulations regarding the reduction or suspension of safe harbor contributions to 401(k) and 403(b) plans under the Internal Revenue Code (Code). These regulations revise and supersede the proposed regulations that were issued on May 18, 2009. The proposed regulations were issued in response to the need of plan sponsors/employers to cease making promised contributions to their 401(k) profit sharing or 403(b) plans during the Great Recession in order to help keep their businesses solvent.
Under the proposed regulations, safe harbor matching contributions and safe harbor nonelective contributions are subject to different requirements. Safe harbor matching contributions may be reduced or suspended during the plan year regardless of the plan sponsor’s financial condition, whereas the plan sponsor must demonstrate a substantial business hardship in order to reduce or suspend a safe harbor nonelective contribution during the plan year. The final regulations eliminate this distinction.
Under the final regulations, all safe harbor contributions may be reduced or suspended during the plan year if one of the following requirements is met:
- The plan sponsor is operating at an economic loss; or
- The safe harbor notice provided to participants for that plan year states 1) the plan might be amended during the plan year to reduce or suspend the safe harbor contribution, 2) a supplemental notice will be provided to participants if a reduction or suspension occurs, and 3) the reduction or suspension will not apply until at least 30 days after the supplemental notice is provided.
In either of the above scenarios, a plan sponsor that wants to reduce or suspend the safe harbor contribution during the plan year will have to 1) amend the plan document, 2) give participants a supplemental notice to explain that safe harbor contributions are being reduced or suspended, and 3) give participants a reasonable opportunity after the supplemental notice is provided and before the reduction or suspension occurs to change their salary deferral elections. The plan must then use current-year nondiscrimination testing for both salary deferral contributions and matching contributions, if any, for the entire plan year in which the reduction or suspension occurs. This could cause problems with a plan passing the nondiscrimination rules and result in the highly compensated participants receiving a return of salary deferral and matching contributions.
If the safe harbor contribution is reduced or suspended during the plan year, then the supplemental notice must explain to participants 1) the consequences of the amendment that reduces or suspends the safe harbor contributions, 2) the procedure for changing salary deferral elections, and 3) the effective date of the reduction or suspension. The reduction or suspension may not be effective before the date the plan amendment is adopted or, if later, 30 days after the supplemental notice is provided to participants. Safe harbor contributions must be provided with respect to amounts deferred by the participant or based on safe harbor compensation paid before the effective date of the reduction or suspension. When calculating the contributions before and after the reduction or suspension, the plan must prorate the annual compensation limit under Treasury Regulations for Code section 401(a)(17). Under Code section 401(a)(17), the annual compensation limit is prorated for a period less than 12 months by reducing the limit in the same proportion as the reduction in the 12-month period. Accordingly, if a calendar year plan sponsor suspends the contribution on June 30, the plan would use ½ of the annual limit (6 months/12 months) in calculating the contribution up to the suspension date. This requirement may cause problems for plan sponsors that do not normally apply the compensation limit ratably over the entire plan year when making safe harbor contributions.
The final regulations apply to amendments reducing or suspending safe harbor nonelective contributions adopted after May 18, 2009 (the effective date provided in the proposed regulations). Because the final regulations eased the requirements on reducing or suspending safe harbor nonelective contributions, any amendment adopted in reliance on the proposed regulations should meet the requirements of the final regulations. The final regulations apply to amendments reducing or suspending safe harbor matching contributions for plan years beginning on or after January 1, 2015.
Conclusions and Next Steps
Unfortunately, many plan sponsors have already provided the safe harbor notice for the 2014 plan year to employees. Those plan sponsors may either revise and reissue the safe harbor notice or accept that safe harbor nonelective contributions can only be reduced or suspended in 2014 if the business is operating at an economic loss. Safe harbor notices issued for plan years beginning in 2015 should include the necessary information to permit a reduction or suspension of safe harbor contributions during the plan year in order to provide maximum flexibility for the plan sponsor.