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Plan Insight

JUNE 2010 Newsletter

Good News for Many Safe Harbor 401(k) Plans

A number of plan sponsors and plan advisors have inquired about the obligation to a safe harbor 401(k) plan in the event the down turn in the economy requires the company to suspend the safe harbor contribution. Until now, only a safe harbor 401(k) plan which utilizes a matching safe harbor contribution was permitted to suspend the matching contribution and continue to operate the plan. A plan which utilizes the nonelective safe harbor contribution (typically a 3% fully vested contribution to all eligible employees) was not permitted to suspend the 3% contribution during the year without terminating the plan.

Fortunately, on May 18, 2009, the Internal Revenue Service (“IRS”) published proposed amendments to certain Treasury Regulations to provide an employer incurring a “substantial business hardship” an alternative to terminating the 401(k) safe harbor plan. An employer meeting certain requirements can reduce or suspend a required safe harbor nonelective contribution without losing their plan’s qualified status.

I. Background.

A 401(k) plan is a qualified retirement savings plan which allows eligible employees to make a cash or deferred election with respect to their wages. In order to qualify under federal income tax laws, a qualified 401(k) plan must satisfy certain nondiscrimination requirements. A 401(k) plan must pass either the “actual deferral percentage” (“ADP”) test or one of the safe harbors. A plan that intends to be a safe harbor 401(k) plan must meet the following requirements:

a. adopt a safe harbor 401(k) plan that specifies whether the employer will make a safe harbor matching or nonelective contribution;

b. maintain the safe harbor 401(k) plan throughout a full plan year subject to certain exceptions (explained below);

c. notify each eligible employee within a reasonable period before the beginning of each plan year of rights and obligations under the plan; and

d. make either matching or nonelective contributions at least as great as the rates required by its safe harbor.

There are exceptions to the general requirement that an employer continue a safe harbor 401(k) plan throughout a full plan year. First, a new 401(k) plan may have a short plan year for the first plan year only. For any other safe harbor 401(k) plan, an employer may either:

i. amend a plan to reduce or suspend safe harbor matching contributions on future employee elective contributions for a plan year, or

ii. terminate its safe harbor plan during the plan year.

II. Substantial Business Hardship.

Under the proposed regulations, an employer that experiences a “substantial business hardship” may amend its safe harbor plan to reduce or eliminate the plan’s safe harbor nonelective contribution. First, the plan must be amended prior to the end of the plan year to reduce or suspend the safe harbor nonelective contribution. Second, following the amendment, the plan must provide that the ADP test (and any other nondiscrimination requirements) will be satisfied for the entire plan year in which the safe harbor nonelective contribution is reduced or suspended. Second, all eligible employees must be given a “supplemental notice”. Also, The reduction or suspension of the safe harbor nonelective contribution can occur no earlier than 30 days after giving eligible employees the supplemental notice. The IRS has stated that, to the extent the final regulations are more restrictive than these proposed regulations, they will not be applied retroactively.

 

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Information is provided for review and consideration only. Please consult legal and tax advisors for practical advice pertaining to your business and personal situations.

This page was last reviewed and/or updated on Friday, July 03, 2015 05:21 PM

 

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