New IRS rules offer relief to safe harbor plans

Employee Benefit News

By Carol A. Weiser, Esq.

July 10, 2009

The Internal Revenue Service recently proposed regulations that would permit employers experiencing a substantial business hardship to suspend or reduce safe harbor non-elective contributions under a 401(k), 401(m) or 403(b) plan during a plan year.

The regulations are intended to provide employers that cannot afford to continue these contributions with an alternative to terminating the entire plan. The proposed regulations are effective for plan amendments adopted after May 18, 2009, and may be relied on now, pending the issuance of final regulations.

Background Plans that meet safe harbor requirements are not required to satisfy the actual deferral percentage (ADP) test under Internal Revenue Code section 401(k) or the actual contribution percentage (ACP) test under Code section 401(m), which also applies to certain 403(b) arrangements.

Generally, an employer must adopt a safe harbor before the plan year begins and make the safe harbor contributions for the entire year, although there are some exceptions to this rule.

…Before the IRS issued these proposed regulations, however, employers making safe harbor non-elective contributions were not able to suspend or reduce those contributions during a plan year.

Proposed rules The proposed regulations, which are similar to the rules for suspension or reduction of safe harbor matching contributions, would allow a safe harbor plan to be amended to suspend or reduce safe harbor non-elective contributions during a plan year if:

• The employer incurs a “substantial business hardship;”• The amendment is adopted after May 18, 2009; • Eligible employees are given a notice describing the suspension or reduction; • The suspension or reduction becomes effective no earlier than 30 days after the date the notice is provided or the amendment is adopted; • Eligible employees are given a reasonable opportunity and period of time before the suspension or reduction takes effect to adjust their Roth or pre-tax deferral elections and employee contributions, if applicable; • The plan is amended to provide that it will satisfy the ADP test and/or the ACP test, using the current year testing method, for the full plan year; and • The plan satisfies the safe harbor non-elective contribution requirements with respect to compensation paid through the amendment’s effective date.

The notice requirement is satisfied if all eligible employees are provided with a notice that describes (1) the consequences of the amendment; (2) the procedures for adjusting the employee’s Roth or pre-tax deferral elections and employee contributions, if applicable; and (3) the amendment’s effective date.

Under the proposed regulations, a “substantial business hardship” is comparable to a substantial business hardship that allows an employer to seek a waiver of the funding requirements for a defined benefit plan under Code section 412(c).

These factors … include, but are not limited to: (1) whether the employer is operating at an economic loss; (2) whether there is substantial unemployment or underemployment in the employer’s trade or business; (3) whether the sales and profits of the employer’s industry are depressed or declining; and (4) whether it is reasonable to expect that the plan will be continued only if relief is granted.

Additional notes As the IRS points out in the preamble to the proposed regulations, given the 30-day advance notice requirements, a suspension or reduction cannot be accomplished by adopting an amendment at the end of a plan year.

Also, a plan implementing a mid-year suspension or reduction of safe harbor non-elective contributions must prorate the compensation limit under Code section 401(a)(17), as described in applicable regulations. In addition, a plan implementing a mid-year suspension or reduction will be subject to the top-heavy rules under Code section 416.…

Carol A. Weiser can be reached at carolweiser@sutherland.com.