By Joseph S. Adams, Philip J. Castrogiovanni and Jeffrey M. Holdvogt of McDermott Will & Emery LLP
Update: Final Regulations Issued
On Nov. 15, 2013, the IRS issued final regulations on mid-year reductions or suspensions of “safe harbor” contributions made to 401(k) plans, revising the proposed regulations issued in May 2009. Safe-harbor notices may need to be revised. See the SHRM Online article "Final Regulations on Suspending 401(k) Safe-Harbor Contributions."
On May 15, 2009, the Internal Revenue Service (IRS) issued proposed regulations that permit sponsors of 401(k) and 403(b) safe harbor retirement plans that experience a "substantial business hardship" to suspend or reduce safe harbor nonelective contributions mid-plan-year, rather than terminate their plans. The proposed rules parallel regulations that allow sponsors of safe harbor matching plans to suspend or reduce matching contributions as an alternative to terminating the plan.
The proposed regulations apply to traditional safe harbor nonelective contributions and safe harbor nonelective contributions under qualified automatic contribution arrangements (QACAs). (For more information on QACAs, see New IRS Final Automatic Contribution Regulations: Key Changes.)
To take advantage of the new rules, a plan sponsor must first determine that it has incurred a substantial business hardship. The occurrence of a substantial business hardship depends on a number of factors, including:
• Whether the employer is operating at an economic loss.
• Whether there is substantial unemployment or underemployment or declining sales and profits in the employer’s industry.
• Whether it is reasonable to expect that the plan will be continued only after the planned reduction or suspension of contributions.
Notice and Timing Requirements
In addition, the plan sponsor must comply with certain notice and timing requirements, including the adoption of a plan amendment and notice to participants at least 30 days prior to the suspension or reduction of contributions.
As a result, plan sponsors cannot wait until the end of the plan year to implement this change. The plan must satisfy the safe harbor nonelective contribution requirements for the portion of the year prior to the suspension or reduction of safe harbor nonelective contributions, and it must satisfy the actual deferral percentage (ADP) and actual contribution percentage (ACP) tests using the current year testing method for the entire plan year. In addition, plan sponsors should consider that the plan will no longer be exempt from top-heavy testing and minimum contribution requirements. (For more on these tests, see Clearing the Annual 401(k) Compliance Test Hurdle.)
Plan sponsors may rely on these proposed regulations immediately. If more restrictive regulations are adopted in the future, they will not be applied with retroactive effect.
Joseph S. Adams is a partner in the law firm of McDermott Will & Emery LLP based in the firm’s Chicago office. As a member of the Employee Benefits Department, he concentrates his practice on employee benefits and executive compensation matters for public, private and tax-exempt. Philip J. Castrogiovanni, a partner in the firm's Chicago office, is a member of the Health Law Department and advises clients on matters pertaining to executive compensation, employee benefits and corporate governance. Jeffrey M. Holdvogt, an associate in the firm's Chicago office, is a member of the Employee Benefits Department.
© 2009 McDermott will & Emery LLP. All Rights Reserved.
This article should not be construed as legal advice.
New Safe Harbor 401(k) Guidance Helps Economically Distressed Employers, Littler Mendelson PC, May 2009
New IRS Regulations Allow Safe Harbor 401(k) Plans to Suspend Non-Elective Contributions, Towers Perrin, May 2009
IRS Allows Safe Harbor Plans to Suspend Nonelective Contributions, Milliman, May 2009
SHRM Online Benefits Discipline