EMPLOYERS FACED WITH SUBSTANTIAL HARDSHIP MAY FIND RELIEF FROM SAFE HARBOR 401(k) REQUIRED CONTRIBUTIONS

On May 18, 2009, the Internal Revenue Service (“IRS”) issued proposed regulations Suspension or Reduction of Safe Harbor Nonelective Contributions.  The regulations would amend Internal Revenue Code (“Code”) Sections 401(k) and 401(m) to allow certain employers who incur a substantial business hardship to reduce or suspend required safe harbor nonelective contributions without having to terminate the plan or lose the plan’s qualified status (currently only reductions or suspensions of employer matching contributions are allowed under certain circumstances).  Though the regulations are proposed, employers may rely on them immediately pending final regulations (any final regulations which are more restrictive will be applied prospectively only).

What is a Safe Harbor 401(k) Plan?
All 401(k) plans must satisfy various nondiscrimination testing requirements including the actual deferral percentage (“ADP”) test or the actual contribution percentage (“ACP”) test if the plan allows for employee contributions or matching contributions.  A Safe Harbor plan utilizes safe harbor alternatives to the required nondiscrimination tests which if followed satisfy the nondiscrimination requirements and also result in the plan being exempt from the top-heavy plan rules.
To qualify for Safe Harbor status an employer must meet the following requirements:

• Employer must adopt a safe harbor plan before the beginning of the plan year;
• The Plan must specify whether the employer will make matching or nonelective contributions;
• Employer must maintain the safe harbor plan for a full plan year subject to the two following exceptions:
• Employer may amend a plan to reduce or suspend safe harbor matching contributions on future employee elective contributions for a plan year, or
• Employer may terminate its safe harbor plan during the plan year.
• Employer must notify each eligible employee of his or her rights under the plan within a reasonable period before the beginning of each plan year; and
• Employer must make either matching or nonelective contributions at least as great as the rates required by the safe harbor requirements.

Proposed Regs
An Employer that suffers a substantial business hardship may amend its plan to reduce or suspend a plan’s safe harbor nonelective contributions if all of the requirements in the proposed regulations are met.  Several factors that are considered in determining if an Employer has suffered a substantial business hardship include, but are not limited to: i) whether the Employer is operating at an economic loss; ii) whether there is substantial unemployment or underemployment in the trade or business and in the industry concerned, and iii) whether the sales and profits of the industry concerned are depressed or declining.  It should be noted that if an employer takes advantage of the proposed regulations it will be subject to the top-heavy plan rules of Code Section 416. 
Under the proposed regulations, an employer will still qualify for safe harbor status if the following requirements are met:

• Employer suffers a substantial business hardship;
• The plan is amended prior to the end of the plan year to reduce or suspend the safe harbor nonelective contributions;
• The plan as amended provides that the ADP test (and ACP test if applicable) will be satisfied for the entire plan year in which the safe harbor nonelective contributions are reduced or suspended;
• All eligible employees must be given a supplemental notice that explains the reduction or suspension of future safe harbor nonelective contributions and its consequences, the procedures for changing employee elections and the effective date of the amendment;
• The reduction or suspension of the safe harbor nonelective contributions can occur no earlier than the later of 30 days after giving eligible employees the supplemental notice and the amendment’s adoption date;
• All eligible employees must be given a reasonable period of time after they receive the supplemental notice (but prior to the reduction or suspension of the safe harbor nonelective contributions) to change their salary deferral elections; and
• The § 401(a)(17) compensation limits (basically $245,000 for 2009) must be prorated.

Link to Proposed Regulations

About the Author: Erin C. V. Bailey, an associate in the Charleston office, is a member of the Bowles Rice Employee Benefits and Executive Compensation Group.