Final Regulations on Suspension or Reduction of Safe Harbor Contributions under Cash or Deferred Arrangements

On November 14, 2013, the Internal Revenue Service (“IRS”) issued final regulations relating to the suspension or reduction of employer safe harbor contributions to certain cash or deferred arrangements (“CODAs”) under Internal Revenue Code (“Code”) section 401(k). Following proposed regulations issued in 2009, the final regulations provide guidance on permissible mid-year reductions or suspensions in safe harbor nonelective contributions, and make certain revisions to the requirements for “safe harbor” matching contributions under a 401(k) or 403(b) Plan.

In order for a CODA (commonly referred to as an “elective contribution” arrangement) to be qualified under the Code, the CODA must satisfy a number of requirements, including satisfying the actual deferral percentage (“ADP”) nondiscrimination test, which compares the deferral percentage of highly compensated employees to the deferral percentage of non-highly compensated employees.

To avoid the burdens of ADP nondiscrimination testing and possible related corrective actions, some plan sponsors rely on design-based safe harbors under Code section 401(k)(13) or 401(k)(12), which allow a plan to automatically satisfy the ADP test. To rely on the design-based safe harbor under Code section 401(k)(13), an employer must make certain nonelective contributions to all non-highly compensated employees during the plan year. To rely on the design-based safe harbor under Code section 401(k)(12), the employer must make certain matching contributions to all non-highly compensated employees during the plan year.

As a general rule, a safe harbor plan must be adopted before the beginning of the plan year and must be maintained throughout the entire plan year, which means that the employer sponsoring a safe harbor plan must make the required nonelective contributions or matching contributions during the entire plan year. The final regulations address the limited circumstances under which an employer may suspend or reduce such contributions prior to the end of the plan year.

Under the 2009 proposed regulations, a plan sponsor could adopt a plan amendment to suspend or reduce nonelective contributions only if the employer incurred a “substantial business hardship,” or terminated the plan. Responding to comments that the criteria for a “substantial business hardship” were unnecessarily burdensome and presented compliance challenges for plan sponsors, the final regulations remove the “substantial business hardship” requirement and introduce two new alternative requirements to suspend or reduce contributions, as follows:

  • An employer may suspend or reduce contributions if the employer is “operating at an economic loss” (as described in Code section 412(c)(2)(A)).
  • The employer may suspend or reduce contributions without regard to the employer’s financial condition if the employer provides notice to participants before the beginning of the plan year disclosing the possibility that contributions might be reduced or suspended mid-year. The notice must state that the plan will send a supplemental notice to plan participants if a reduction or suspension does occur, and the reduction or suspension will not apply until at least 30 days after the supplemental notice is provided.

If an employer suspends or reduces safe harbor nonelective contributions:

  • The suspension or reduction of the nonelective contributions may not take effect until 30 days after the supplemental notice is provided to all eligible employees.
  • 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 ADP test will be satisfied for the entire plan year in which the suspension or reduction occurs, using the current year testing method.
  • The plan must satisfy the safe harbor contribution requirement with respect to safe harbor compensation paid through the effective date of the amendment.

In an effort to achieve uniformity, the IRS also used the final regulations to modify the rules that apply to mid-year amendments to suspend or reduce employer matching contributions under the alternative 401(k)(12) safe harbor requirements. Under the final regulations, an employer who makes matching contributions under 401(k)(12) may only suspend or reduce the contributions mid-year if the employer satisfies the same conditions required under the final regulations for mid-year suspension of nonelective contributions.

The regulations are effective for safe harbor nonelective contributions and safe harbor matching contributions for plan years beginning on or after January 1, 2015.