On November 14, 2013, the Internal Revenue Service issued final regulations that permit employers to suspend or reduce safe harbor nonelective contributions under a 401(k), 401(m), or 403(b) plan during the plan year. The final regulations also revise the requirements that apply to mid-year suspensions or reductions of safe harbor matching contributions. The final regulations are generally effective for plan amendments adopted after May 18, 2009, while the new requirements that apply to safe harbor matching contributions are effective for plan years beginning on or after January 1, 2015.
Plans maintained under Internal Revenue Code (IRC) sections 401(k) and 401(m) and certain contributions under IRC section 403(b) plans must meet nondiscrimination and other requirements to keep their tax-favored status. This usually requires yearly testing to establish that the benefits provided under a plan do not discriminate disproportionately in favor of highly compensated employees, often referred to as the “ADP test” and the “ACP test.” Plans that meet certain safe harbor requirements, however, are not required to perform these nondiscrimination tests. To satisfy the IRC nondiscrimination safe harbors, an employer must, among other requirements, make either safe harbor matching or safe harbor nonelective contributions to the plan each year on behalf of its non-highly compensated employees. Generally, an employer must adopt a safe harbor contribution before the plan year begins and make these contributions for the entire year, subject to certain exceptions.
Under the originally issued final regulations, employers could terminate a safe harbor plan mid-year, or they could suspend or reduce safe harbor matching contributions mid-year for any reason if certain other conditions were met. However, employers were not permitted to suspend or reduce safe harbor nonelective contributions during a plan year. In 2009, the IRS issued proposed regulations allowing employers to suspend or reduce safe harbor nonelective contributions if the employer experienced a “substantial business hardship.” For this purpose, a “substantial business hardship” was comparable to a substantial business hardship under the IRC section 412 funding rules. Factors used to determine whether an employer had suffered a “substantial business hardship” included (i) whether the employer was operating at an economic loss, (ii) whether there was substantial unemployment or underemployment in the employer’s trade or business, (iii) whether the sales and profits of the employer’s industry were depressed or declining, and (iv) whether it was reasonable to expect that the plan would only be continued if relief was granted.
The final regulations modify the proposed regulations by loosening the standards under which nonelective contributions may be suspended or reduced, and by imposing new, similar restrictions on the suspension or reduction of safe harbor matching contributions.
Summary of New Guidance
The final regulations modify the “substantial business hardship” standard for suspending or reducing safe harbor nonelective contributions, replacing that standard with an “operating at an economic loss” standard. The economic loss standard is intended to be more objective and avoid the factual uncertainty of some of the “substantial business hardship” requirements. The final regulations also allow an employer to suspend or reduce safe harbor nonelective contributions for any reason if the employer provides participants with notice before the beginning of the plan year that discloses the possibility that contributions may be suspended or reduced during the plan year. This notice must explain that participants will receive a supplemental notice if the suspension or reduction does occur, and that the suspension or reduction will not apply until at least 30 days after the supplemental notice is provided. The following additional conditions, which remain unchanged from the conditions that applied to safe harbor matching contributions in the original final regulations, must also be met:
Employees are given a supplemental notice describing the suspension or reduction;
The suspension or reduction becomes effective no earlier than the later of (i) 30 days after the supplemental notice is provided, or (ii) the date the amendment is adopted;
Employees are given a reasonable opportunity and period of time before the suspension or reduction takes effect to adjust their deferral elections;
The plan is amended to provide that it will satisfy the ADP and/or the ACP test, using the current year testing method, for the full plan year; and
The plan satisfies the safe harbor contribution requirement through the amendment’s effective date.
In order to achieve uniformity between the rules that apply to a mid-year suspension or reduction of safe harbor matching contributions and a mid-year suspension or reduction of safe harbor nonelective contributions, the final regulations also modify the rules that apply to mid-year suspensions or reductions of safe harbor matching contributions. Safe harbor matching contributions can still be suspended or reduced for any reason, but effective January 1, 2015, the employer must provide participants with notice before the beginning of the plan year which discloses the possibility that contributions may be suspended or reduced mid-year. Suspensions or reductions as a result of operating at an economic loss are also permitted. The additional requirements described above will continue to apply to a suspension or reduction of matching contributions.
Adam B. Cohen, partner, and Brenna Clark, associate, are employee benefits specialists with Sutherland Asbill and Brennan LLP.
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