IRS Permits Mid-Year Changes to 401(k) Safe Harbor Contributions

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On November 14, 2013, the Internal Revenue Service issued final regulations that permit mid-year reductions or suspensions of safe harbor nonelective contributions, and that modify the rules permitting mid-year reductions or suspensions of safe harbor matching contributions, to 401(k) plans (the "Final Regulations").

As way of background, the Internal Revenue Code ("Code") provides that contributions to a 401(k) plan cannot be discriminatory in favor of highly compensated employees, which can be demonstrated through annual complex nondiscrimination tests. As an alternative, a 401(k) plan sponsor can also demonstrate that its plan is not discriminatory by making safe harbor matching or nonelective contributions to the 401(k) plan, and by providing participants with notice of the safe harbor contributions.

Prior to the issuance of the Final Regulations, employers who elected to make safe harbor nonelective contributions to a 401(k) plan were required to make such contributions throughout the full plan year, regardless of whether the employer was operating at a loss for the year. However, employers who elected to make safe harbor matching contributions to a 401(k) plan were allowed to reduce or suspend such matching contributions at any time during the plan year as long as the amendment was adopted and participants were given notice of the reduction or suspension at least 30 days prior to the effective date, and as long as participants were allowed to change their contribution elections under the plan.

As a result of the Final Regulations, retroactively effective for amendments adopted after May 18, 2009, employers can reduce or suspend safe harbor nonelective contributions any time during the plan year with 30 days’ advance notice if: (i) the employer is operating at an economic loss (as defined in the Code); or (ii) the employer provided notice to employees before the beginning of the plan year that the safe harbor nonelective contributions might be reduced or suspended during the year. It is important to note that any actions taken in accordance with the proposed regulations issued May 18, 2009, which permitted mid-year reductions or suspensions of safe harbor nonelective contributions if the employer incurred a "substantial business hardship," of which economic loss was just one factor, will comply with the Final Regulations.

In addition, to achieve uniformity, the rules that apply to mid-year amendments reducing or suspending safe harbor matching contributions were revised in the Final Regulations to mirror the rules that apply to mid-year amendments reducing or suspending safe harbor nonelective contributions. As such, effective January 1, 2015, employers can reduce or suspend safe harbor matching contributions any time during the plan year with 30 days’ advance notice if: (i) the employer is operating at an economic loss (as defined in the Code); or (ii) the employer provided notice to employees before the beginning of the plan year that the safe harbor matching contributions might be reduced or suspended during the year.

Based on the Final Regulations, we recommend that employers add language to their 2014 401(k) safe harbor notices, which are required to be provided to participants no later than December 2, 2013, indicating that the safe harbor matching or nonelective contributions may be reduced or suspended during the year.

Topics:  401k, IRS, Retirement Plan, Safe Harbors

Published In: Finance & Banking Updates, Labor & Employment Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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