5/22/2009

Suspension or Reduction of Safe Harbor Nonelective Contributions

On May 18, 2009, the IRS released proposed amendments to Treasury Regulation 1.401(k)-3 and 1.401(m)-3 permitting the suspension or reduction of safe harbor nonelective contributions in a qualified plan. Previously, plans were only permitted to cease safe harbor nonelective contributions upon termination of the plan for specified situations. Taxpayers may rely on the proposed regulations.

The procedure for suspending safe harbor nonelective contributions is nearly the same as those required for safe harbor matching contributions. The main difference requires safe harbor nonelective plans to incur a substantial business hardship before the safe harbor contributions may be reduced or suspended. We have released a sample amendment on our system for plans that wish to terminate safe harbor nonelective contributions. This supplements the sample amendment to cease safe habor matching contributions already on the system. As always, this amendment is available free of charge to our subscribing retirement document customers.

The sample amendment provided by ftwilliam.com will be pre-populated with plan information to the extent possible. It includes a consent action / formal record of action (depending on the entity type of the plan sponsor), notice of suspension of safe harbor contributions combined with a Summary of Material Modifications (SMM), and sample amendment. The sample amendment provided will cease safe harbor qualified nonelective contributions. The amendment will also show times when Participants may modify elections that are based on current plan provisions that may be modified or removed if necessary.

Below, we will describe the procedure to reduce or suspend safe harbor nonelective contributions in a qualified plan. Note that a plan may be subject to top heavy rules and may end up making a 3% contribution to the plan under IRC section 416. Therefore, plans should carefully evaluate whether amending the plan to remove safe harbor contributions will be a worthwhile exercise.

  1. The plan sponsor must incur a substantial business hardship comparable to a hardship described in Internal Revenue Code section 412(c) (formerly section 412b; provides rules for minimum funding standards. Under 412(c), the factors taken into account in determining a substantial business hardship include (but are not limited to) whether or not:

    • the employer is operating at an economic loss,
    • there is substantial unemployment or underemployment in the trade or business and in the industry concerned, and
    • the sales and profits of the industry concerned are depressed or declining.

  2. The plan sponsor must adopt an amendment to reduce or suspend safe harbor nonelective contributions and provide that the plan will be required to meet the ADP and ACP test (to the extent applicable) for the entire plan year.

  3. The amendment must be effective no earlier than the later of May 18, 2009 and 30 days after eligible employees are provided a notice that includes the following information:

    • the consequences of the amendment reducing safe harbor contributions (i.e. the employer will no longer make a nonelective contribution to the plan),
    • procedures to change elective deferrals under the plan, and
    • the effective date of the amendment.

  4. Eligible employees must be provided a reasonable opportunity prior to the reduction or suspension of safe harbor contributions to change their elective deferrals. This requirement is presumably met if employees are provided at least 30 days to freely change their elections.

  5. The plan will be required to meet ADP and ACP (to the extent applicable) tests for the entire plan year. The plan will also be subject to the top heavy rules under section 416. If a key employee defers 3% or more of his or her compensation, then the plan will end up making a 3% contribution to the plan to satisfy top heavy rules and amending the plan to cease the safe harbor contribution may not have been worth the effort.

  6. Any safe harbor contributions made will be required to prorate the 401(a)(17) compensation limit (as required by Treas. Reg. 1.401(a)(17)-1(b)(3)(iii)(A)). For example, if the safe harbor nonelective contributions are ceased on June 30, 2009 for a calendar year plan, the 401(a)(17) limit will be prorated to 1/2 of $245,000 or $122,500.

The IRS is considering requiring the annual notice provided by safe harbor plans at the beginning of each plan year to inform eligible employees of the possibility of reduced or suspended safe harbor contributions. This requirement would not apply until plan years beginning on or after January 1, 2010.

If you have any questions please feel free to contact us at support@ftwilliam.com or call 800.596.0714.

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