• IRS Proposes Relief for Safe Harbor Plans
  • June 23, 2009 | Author: James C. Bruinsma
  • Law Firm: Miller Johnson - Grand Rapids Office
  • The IRS published proposed regulations on May 15, 2009 that provide relief to an employer that is making “safe harbor” nonelective employer contributions to a 401(k) plan and experiences a substantial business hardship. The employer may now amend its 401(k) plan during a plan year to reduce or suspend the amount of “safe harbor” nonelective employer contributions being made to the plan. The same rule also applies to 403(b) plans.

    Background

    A 401(k) plan is required to satisfy nondiscrimination rules with regard to 401(k) contributions and matching contributions. The nondiscrimination tests are called the ADP and ACP tests. However, an employer that makes either “safe harbor” nonelective employer contributions or “safe harbor” matching contributions is considered to satisfy the nondiscrimination requirements.

    A “safe harbor” nonelective employer contribution must be equal to at least 3% of each eligible participant’s compensation. To make “safe harbor” nonelective employer contributions, the employer is required to send a notice to the participants at least 30 days before the beginning of the plan year that informs the participants of the employer’s intent to make the “safe harbor” nonelective employer contributions for the next plan year.

    IRS regulations did not contain any provision that allowed an employer to reduce or suspend “safe harbor” nonelective employer contributions during a plan year for which a “safe harbor” notice was provided. The employer’s only option during a plan year to avoid future contributions was to terminate the 401(k) plan.

    The rules for “safe harbor” matching contributions are different. An employer is permitted to reduce or suspend “safe harbor” matching contributions during a plan year.

    The New Rule

    The IRS proposed regulations will now permit an employer to reduce or suspend “safe harbor” nonelective employer contributions during a plan year if certain requirements are satisfied:

    • The employer has a “substantial business hardship.” (This is not a requirement to reduce or suspend “safe harbor” matching contributions.)
    • The employer notifies the participants of its intent to reduce or suspend the “safe harbor” nonelective employer contributions at least 30 days before the change occurs.
    • The employer amends its 401(k) plan to reduce or suspend the “safe harbor” nonelective employer contributions before the end of the plan year. The amendment must provide that the ADP and ACP tests will apply for the entire plan year. The current year testing method must be used for purposes of these ADP and ACP tests.
    • The participants are permitted to change the amount of their 401(k) contributions before the effective date of the amendment.
    • The employer makes the “safe harbor” nonelective employer contributions for the portion of the plan year before the effective date of the amendment. For purposes of calculating this amount, the dollar limit on a participant’s compensation during a plan year ($245,000 for 2009) is pro rated for the period before and after the amendment.

    An important issue is whether the employer has a “substantial business hardship.” The factors used to determine whether this requirement is satisfied include:

    • Whether the employer is operating at an economic loss.
    • Whether there is substantial unemployment or underemployment in the employer’s trade or business.
    • Whether the sales and profits of the employer’s industry are depressed or declining.
    • Whether it is reasonable to expect that the plan will be continued only if relief is granted.

    The new rules apply to amendments adopted on or after May 18, 2009. Therefore, even though the IRS regulations are in proposed form, employers may rely on the regulations at this time.