IRS Issues Guidance on Suspension of Safe Harbor Nonelective Contributions

On May 18, 2009, the Internal Revenue Service issued proposed Treasury regulations that permit employers who sponsor a safe harbor 401(k) or 403(b) plan to reduce or suspend nonelective contributions in the event that the employer incurs a “substantial business hardship.” The proposed regulations are generally consistent with final regulations that permit an employer to suspend or reduce safe harbor matching contributions.

For purposes of the proposed regulations, whether an employer incurs a “substantial business hardship” is generally based on all relevant facts and circumstances including (but not limited to) the following:

  • Whether the employer is operating at an economic loss;
  • Whether there is substantial unemployment or underemployment in the trade or business and in the industry concerned;
  • Whether the sales and profits of the industry concerned are depressed or declining; and
  • Whether it is reasonable to expect that the plan will be continued only if the safe harbor contributions are suspended or reduced.

The proposed regulations provide that employers can suspend or reduce safe harbor nonelective contributions if the following requirements are satisfied:

  • All eligible employees must be provided notice of the suspension or reduction;
  • The suspension or reduction of the safe harbor nonelective contributions may not take effect until the later of 30 days after the notice is provided to all eligible employees or 30 days after the date the amendment relating to the suspension or reduction is effective;
  • Eligible employees must be given a reasonable opportunity to change their deferral elections prior to the suspension or reduction of the safe harbor nonelective contribution;
  • The plan must be amended to provide that the average contribution percentage test will be satisfied for the entire plan year in which the suspension or reduction occurs, using the current year testing method; and,
  • The plan must satisfy the safe harbor nonelective contribution requirement with respect to safe harbor compensation paid through the effective date of the amendment.

If the plan is relying on the safe harbor to be exempt from the top-heavy rules and is amended to reduce or suspend safe harbor nonelective contributions, it is subject to the rules of Section 416 of the Internal Revenue Code, and must meet the minimum contribution and other top-heavy requirements.

The proposed regulations also require the supplemental notice listed above to specifically explain:

  • the consequences of the exiting amendment;
  • the procedures for changing a deferral election; and
  • the effective date of the amendment.

These supplemental notice requirements are identical to the rules that currently apply to the rules for a safe harbor match.

The regulations are proposed to be effective for amendments adopted after May 18, 2009, and employers may rely on them for guidance pending the issuance of final regulations. The IRS has requested comments on the proposed regulations.

Please contact our office for more information on the proposed regulations and how they may impact your plans.