Final rules allow for reduction or suspension of safe harbor 401(k) nonelective and matching contributions

The IRS has issued final regulations that allow employers sponsoring a safe harbor 401(k) plan, including a qualified automatic contribution arrangement (QACA) under Code Sec. 413, to reduce or suspend required nonelective and matching contributions in the event they are operating at an “economic loss” during the plan year. The rules alternatively allow an employer to suspend contributions if notice is provided to participants before the beginning of the year disclosing the possibility that contributions might be reduced or suspended during the year. The final regulations modify proposed rules issued in May 2009 by equalizing the conditions applicable to the suspension of safe harbor nonelective and matching contributions. However, the final rules make the conditions under which safe harbor matching contributions may be reduced or suspended more strict.

Reduction of safe harbor matching contribution

A plan using the safe harbor matching contribution method may be amended during the plan year to reduce or eliminate matching contributions on future elective and employee contributions during the plan year and instead use current year ADP and ACP (if applicable) nondiscrimination testing for the plan year. The use of the safe harbor may only be discontinued prospectively, and only under specified conditions. Among the requirements, a supplemental notice must be provided to each eligible employee (in writing or other prescribed formula) explaining the consequences of the amendment that reduces or suspends matching contributions on future elective contributions and (if applicable) employee contributions; the procedures for changing the cash or deferred election; and the effective date of the amendment. In addition, the reduction or suspension of matching contributions may take effect no earlier than the later of (a) 30 days after eligible employees are given the supplemental notice and (b) the date the amendment is adopted. However, under the prior rules an employer was not required to demonstrate substantial hardship or economic loss in order to reduce matching contributions.

Absent authority to reduce or suspend the nonelective contributions, employers may have felt pressured into the position of terminating the plan. Although a safe harbor plan must generally satisfy the requirements of Code Sec. 401(k)(12) and Code Sec. 401(m)(11) and the governing regulations for an entire 12-month plan year, the plan may be terminated during the plan year (i.e., before the expiration of the 12-month period) in connection with a merger or acquisition or in response to a substantial business hardship incurred by the employer.

Reducing safe harbor nonelective and matching contributions

The proposed rules would have allowed for the reduction or suspension of safe harbor nonelective contributions, including those under QACAs, if, among other conditions, the employer had incurred a “substantial business hardship.” Factors contributing to a determination of substantial business hardship would, under Code Sec. 412(c), have included whether: the employer was operating at an economic loss, there was substantial unemployment or underemployment in the employer’s trade or business and in the industry; the sales and profits of the industry were depressed or declining; and it was reasonable to expect that the plan would be continued only if the relief was granted. Significantly, as noted above, the requirement that an employer incur a substantial business hardship did not apply to the reduction or suspension of safe harbor matching contributions.

The final rules no longer require an employer to have incurred a substantial hardship in order to reduce or suspend safe harbor nonelective contributions. However, in order to reduce or suspend safe harbor nonelective or matching contributions, the employer must be “operating at an economic loss,” as described in Code Sec. 412(c)(2)(A), for the plan year. Thus, the ability to reduce or suspend safe harbor nonelective or matching contributions would not be conditioned on the health of the employer’s industry or whether the plan would be able to continue absent the reduction or suspension of contributions.

Alternatively, the final rules authorize a reduction or suspension of contributions, without regard to the financial condition of the employer if notice is provided to plan participants before the beginning of the plan year, disclosing the possibility that the contributions might be reduced or suspended mid-year and the reduction or suspension will not apply until at least 30 days after all eligible employees are provided notice of the reduction or suspension.

Effective dates

The final rules applicable to the reduction or suspension of safe harbor nonelective contributions retroactively apply to amendments adopted after May 18, 2009. However, because the restrictions on the ability of an employer to reduce or suspend safe harbor matching contributions are new, the final rules applicable to matching contributions will not go into effect before plan years beginning on or after January 1, 2015.

Under the proposed regulations, the reduction or suspension of nonelective contributions could be effective no earlier than the later of 30 days after eligible employees were provided the supplemental notice and the date the amendment is adopted. The final rules clarify that the reduction or suspension of safe harbor nonelective or matching contributions may not take effect earlier than the later of the date the amendment (reducing or suspending safe harbor contributions) is adopted or 30 days after eligible employees are provided the required supplemental notice. The IRS explains that the minimum 30-day waiting period applies solely with respect to the date the supplemental notice is provided and not to the date the amendment is adopted.

Source: 78 FR 68735.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

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