IRS Permits Suspension or Reduction of Safe Harbor Nonelective Contributions
May 22, 2009
Under current economic conditions, many employers have amended their 401(k) or 403(b) plans to reduce or suspend safe harbor matching contributions on future employee deferrals. A safe harbor plan may be amended to reduce or suspend matching contributions if the following conditions are met:
- all eligible employees are notified of the amendment and the procedures for changing their deferral elections;
- the reduction or suspension is effective no earlier than the later of 30 days after employees are notified and the date the amendment is adopted; and
- eligible employees have a reasonable opportunity to change their deferral elections before the amendment is effective.
Previously, the only way to eliminate safe harbor nonelective contributions was to terminate a plan. However, the Internal Revenue Service recently proposed regulations that would permit an employer to amend its plan to reduce or suspend these nonelective contributions if the employer incurs a substantial business hardship, meets the conditions described above and satisfies the ADP test (and ACP test, if applicable) for the entire year. The employer must make all nonelective contributions until the effective date of the amendment and must prorate the annual compensation limit (e.g., $245,000 for 2009) for the period during which contributions are made. All plans in which any safe harbor contributions are stopped during the year also must satisfy top-heavy testing for the entire year.
For this purpose, a “substantial business hardship” generally means that the employer is operating at an economic loss, there is substantial unemployment or underemployment in the trade or business of the employer and in its industry, the sales and profits of the industry are depressed or declining, and it is reasonable to expect that the plan will be continued only if contributions are reduced or suspended. Some employers are interested in reducing or suspending contributions in order to avoid substantial business hardship. The IRS is likely to receive comments that the substantial business hardship test is too stringent, and that the proposed regulations do not go far enough in permitting reduction or suspension of safe harbor nonelective contributions. We will have to wait to see whether the final regulations are revised in this respect.
The proposed regulations are effective for amendments to reduce or suspend safe harbor nonelective contributions that are adopted after May 18, 2009. Employers may rely on the proposed regulations pending issuance of final regulations.