Mid-Year Elimination of Safe Harbor Non-elective Contributions

July 23, 2009 (PLANSPONSOR (b)lines) - While many plan sponsors are resorting to cutting back or eliminating company match contributions in a effort to reduce costs, does recent guidance from the Internal Revenue Service on eliminating safe harbor non-elective contributions offer an alternative solution?

In May, the IRS proposed rules that would permit employers affected by substantial business hardship to decide mid-year to reduce or suspend safe harbor non-elective contributions to 401(k) and 403(b) plans (see IRS Opens Door for Safe Harbor Contribution Cuts ). What does this mean for 403(b) plan sponsors?


In order for a 403(b) plan (or 401(k) plan) to meet nondiscrimination testing on a “safe harbor” basis, the employer is required to make either a matching or non-elective contribution.   This is true whether the plan’s safe harbor status is based on the traditional safe harbor or the more recent Qualified Automatic Contribution Arrangement design.   Generally, a plan’s status as a safe harbor plan, and the required employer contributions, must continue for the entire 12-month plan year.   

IRS regulations have long permitted an employer to amend its “safe harbor” 403(b) plan (or 401(k) plan) to suspend or reduce matching contributions mid-year, if certain requirements are met, including 30-day advance notice to eligible employees, provided the same level of matching contributions continues to be made through the effective date of the amendment and the plan meets the ADP test for the entire plan year on a “current year” testing basis.   In addition, eligible employees must be provided a reasonable opportunity to change their deferral election prior to the effective date of the suspension or reduction.

However, prior to the issuance of the new proposed regulations, the IRS regulations did not address whether an employer could suspend safe harbor non-elective contribution mid-year, suggesting that this was not permissible.   Instead, under the existing regulations, an employer may suspend its obligation to make safe harbor non-elective contributions mid-year only by terminating its safe harbor plan, a draconian step most employers wish to avoid.  

Strict Conditions

Still, under the proposed rules, the conditions for terminating a plan providing a safe harbor non-elective contribution mid-year are high.   Basically, termination is permissible only in associate with a corporate transaction or if the employer “incurs a substantial business hardship comparable to a substantial business hardship described in section 412(c)”.  

Under Code section 412(c), a facts and circumstances test determines whether an employer has incurred a “substantial business hardship.”   Some of the factors include (but are not limited to) whether:

  • 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.

In addition, a plan sponsor must satisfy the same rules relating to employee notification and discrimination testing that apply to the mid-year suspension of safe harbor matching contributions.   The effect of the new guidance is that, if an employer can meet the requirements to terminate its safe harbor plan mid-year, it may instead simply suspend or reduce the non-elective contribution.  

As stated above, this is a difficult standard to meet and, therefore, it is unclear how helpful the new proposed guidance may be.   In any event, the proposed regulations clarify that, if safe harbor employer contributions – matching or non-elective – are suspended or reduced mid-year, the section 401(a)(17) compensation limit must be prorated, and the plan will become subject to the top-heavy rules.

The proposed regulations provide that employers may rely on them for amendments adopted after May 18, 2009.   Any provision in the final regulations that is more restrictive will apply prospectively.

If a company sponsoring a safe harbor 403(b) plan that provides a safe harbor non-elective contribution is interested in suspending or reducing its non-elective contribution, it should first determine whether it meets the "substantial business hardship" standard.  

The sponsor must keep in mind that the plan must be amended to reflect the suspension or reduction of the safe harbor non-elective contribution, as well as the application of ADP/ACP testing for the year, before the change may be effective.    In other words, the amendment cannot be adopted at year-end, and made retroactively effective.  

The company should also keep in mind that the suspension or reduction will entail a participant notice that must be provided at least 30 days before the suspension or reduction is effective.  Therefore, in order to suspend or reduce contributions in 2009, sponsors must begin to take action soon.

- Kendall W. Daines, Groom Law Group, Chartered

NOTE: This feature is to provide general information only, does not constitute legal advice as part of an attorney-client relationship, and cannot be used or substituted for legal or tax advice.