On May 18, 2009, the Internal Revenue Service issued proposed regulations allowing safe harbor 401(k) plan sponsors that experience a “substantial business hardship” to suspend or reduce safe harbor nonelective contributions during a plan year. The proposed rules are similar to regulations already in place for safe harbor matching contributions, but the “substantial business hardship” prerequisite for nonelective contributions does not apply in the matching contributions context.
Background
A safe harbor 401(k) plan is one treated as satisfying certain nondiscrimination tests (the so-called “ADP” and “ACP” tests) because employer contributions satisfy specified safe harbor rules. Employer contributions to satisfy the safe harbor may be either matching contributions or nonelective contributions.
A safe harbor 401(k) plan generally must be maintained throughout the entire plan year. However, existing regulations have permitted the reduction or suspension of safe harbor matching contributions (but not nonelective contributions) during the plan year. Before the issuance of the proposed regulations, safe harbor plans were not permitted to reduce, suspend or eliminate employer nonelective contributions during the plan year, except by terminating the plan in its entirety. The new proposed rules extend the exception applicable to employer matching contributions to nonelective contributions, provided that certain conditions are satisfied (including the employer’s “substantial business hardship”).
Proposed Guidance
The proposed regulations allow an employer that suffers a “substantial business hardship” to amend its plan to reduce or suspend the plan’s safe harbor nonelective contributions. Factors to be considered in determining whether a “substantial business hardship” exists include whether:
- the employer is operating at an economic loss
- there is substantial unemployment or underemployment in the trade or business and in the industry concerned, and
- the sales and profits of the industry concerned are depressed or declining.
If an employer is able to demonstrate that a “substantial business hardship” exists, then the employer may amend the plan to suspend or reduce safe harbor nonelective contributions during the plan year, if all of the following requirements are satisfied:
- eligible employees must be given a “supplemental notice” that explains (i) the reduction or suspension of future safe harbor nonelective contributions and its consequences, (ii) the procedures for changing employee elections, and (iii) the effective date of the amendment
- the reduction or suspension cannot be effective earlier than 30 days after the supplemental notice is provided or, if later, the date the amendment is adopted
- eligible employees must be given a reasonable period of time (including a reasonable period after receiving the supplemental notice) prior to the reduction or suspension to change their 401(k) deferral elections
- the plan is amended to provide that the applicable nondiscrimination tests will be satisfied for the entire plan year in which the safe harbor nonelective contributions are reduced or suspended, using the “current year” testing method
- the plan must satisfy the “top-heavy” requirements for the plan year, and
- the plan must limit compensation on which the employer safe harbor contribution through the effective date of reduction or suspension is based to a prorated amount of the $245,000 annual limit, to reflect the shortened safe harbor contribution period.
The proposed regulations, which may be relied on by plan sponsors pending the issuance of a final rule, are effective for amendments adopted after May 18, 2009.
Conclusion
In the current economic climate, plan sponsors have been forced to consider ways to reduce the costs associated with maintaining qualified retirement plans. Accordingly, many plan sponsors have considered whether they can reduce or suspend employer contributions to a safe harbor 401(k) plan. The proposed regulations, although not as “sponsor-friendly” as the current regulations applicable to safe harbor matching contributions, provide an alternative to plan termination for plan sponsors with respect to safe harbor nonelective contributions, if the “substantial business hardship” condition can be met.
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This article is republished with permission of Pepper Hamilton, LLP. Further duplication without the permission of Pepper Hamilton, LLP is prohibited. All rights reserved.