There has been concern recently that many employers might terminate their retirement plans to avoid violating the safe harbor 401(k) rules. Because of this concern, the Internal Revenue Service has issued proposed regulations relating to certain cash or deferred arrangements and matching contributions under Section 401(k) plans and Section 403(b) plans.
The proposed regulations are designed to give employers an alternative to terminating their safe harbor plans. The proposal would permit an employer sponsoring a safe harbor plan that incurs a substantial business hardship to reduce or suspend safe harbor non-elective contributions during a plan year. The reductions or suspensions of certain non-elective contributions to employees' individual plan accounts are contingent on plan sponsors following certain notice and timing procedures.
There are five tests that must be met in order for an employer in a 401(k) or 403(b) plan to safely reduce or suspend safe harbor non-elective contributions.
First, all eligible employees must be provided a supplemental notice of the reduction or suspension. The supplemental notice requirement is satisfied if each eligible employee is given a written notice explaining: (1) the consequences of the amendment reducing or suspending future safe harbor non-elective contributions; (2) the procedures for changing cash or deferred elections and, if applicable, employee contribution elections; and (3) the effective date of the amendment to the plan.
The second requirement is that the reduction or suspension of safe harbor non-elective contributions can become effective no earlier than the later of 30 days after eligible employees are provided the supplemental notice and the date the amendment is adopted. Because the reduction or suspension of safe harbor contributions can be effective no earlier than the later of 30 days after the notice is provided to all eligible employees and the date the amendment is adopted, an employer that wants to reduce or suspend safe harbor contributions during a year could not implement this change by adopting the amendment at the end of the plan year.
For the third requirement, eligible employees must be given a reasonable opportunity (including a reasonable period after receipt of the supplemental notice) prior to the reduction or suspension of the safe harbor non-elective contributions to change their cash or deferred elections and, if applicable, their employee contribution elections.
The fourth requirement is that the plan must be amended to provide that the ADP test will be satisfied for the entire plan year in which the reduction or suspension occurs, using the current year testing method.
Finally, the plan must meet the safe harbor non-elective contribution requirement with respect to safe harbor compensation paid through the effective date of the amendment.
A plan that is amended during the plan year to reduce or suspend safe harbor contributions (whether non-elective contributions or matching contributions) must prorate the otherwise applicable compensation limit. Also, a plan that is amended to reduce or suspend safe harbor contributions becomes subject to the top-heavy rules under Section 416.
Substantial business hardship is based on such factors as: (1) operation at an economic loss; (2) substantial industry unemployment; (3) depressed industry sales; and (4) expected plan continuation upon granting of waiver.
The regulations are proposed to be effective for amendments adopted after May 18, 2009. Taxpayers may rely on the proposed regulations for guidance pending the issuance of final regulations. However, if, and to the extent, the final regulations are more restrictive than the guidance in the proposed regulations, the provisions of the final regulations will be applied prospectively only.
Prop. Treas. Regs. §§1.401(k)-3(g), 1.401(m)-3(h).
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