On May 18, 2009, the IRS issued new proposed regulations which permit companies that sponsor “safe-harbor” 401(k) plans to suspend making mandatory contributions to the plan due to adverse economic conditions affecting the company’s business without disqualifying the 401(k) plan. These important new regulations provide companies which elected to satisfy the 401(k) safe-harbor requirements by agreeing to make “non-elective contributions” to the plan with an alternative to terminating their plan if they are currently experiencing a temporary downturn in their business.
Summary of Safe-Harbor 401(k) Rules
Generally, companies which sponsor 401(k) plans must satisfy certain non-discrimination rules which requires that the benefits provided under the plan do not disproportionately benefit the highly-compensated employees of the company. However, 401(k) plans that meet certain safe-harbor requirements are exempt from performing these non-discrimination tests. There are generally two types of safe-harbor 401(k) plans. The first type of safe-harbor 401(k) plan requires the company to make a certain level of contributions based upon the amount of contributions the employees elect to make to the plan (“safe-harbor matching contributions”). The second type of safe-harbor 401(k) plan requires the company to make contributions equal to three percent (3%) of the participant’s compensation (“safe-harbor non-elective contributions”) regardless of whether the participant makes any contributions to the plan. A company which intends to use a safe-harbor 401(k) plan design must provide notice to the plan participants at least thirty (30) days in advance of each plan year. Such notice must specify which of the two safe-harbor plan designs that the company intends to satisfy in order to be exempt from the 401(k) non-discrimination requirements for the following year.
Prior Safe-Harbor 401(k) Regulations
The prior regulations issued by the IRS permitted a company that elected to comply with the 401(k) safe-harbor by making safe-harbor matching contributions to suspend the safe-harbor matching contributions during a plan year for any reason so long as the company provided at least thirty (30) days advance notice of such suspension to the plan participants and made the matching contributions through the effective date of the suspension. However, under the prior regulations, a company that elected to comply with the 401(k) safe-harbor by making safe-harbor non-elective contributions was not able to suspend such contributions without terminating the plan.
New Safe-Harbor 401(k) Regulations
The IRS has addressed this difference between the two types of safe-harbor 401(k) plans by adding a new provision to the regulations governing 401(k) plans which now permits a company which elected to satisfy the safe-harbor requirements by making safe-harbor non-elective contributions to suspend those contributions under certain circumstances. Under the new regulations, a company is permitted to suspend their safe-harbor non-elective contributions as a result of a “substantial business hardship”. The factors used to determine whether a company has suffered a “substantial business hardship” include (but are not limited to) (i) whether the company is operating at an economic loss, (ii) whether there is substantial unemployment in the company’s trade or business, (iii) whether the sales and profits of the company’s industry are depressed or declining and (iv) whether it is reasonable to expect the plan will not be continued unless the mandatory contributions are suspended.
If the company determines that a “substantial business hardship” has occurred and, as a result, wishes to suspend making the safe-harbor non-elective contributions, the company must provide the plan participants with a notice explaining the reasons for the elimination of the safe-harbor non-elective contributions and provide the participants with an opportunity to change their elections to contribute to the plan. The company must also amend the plan to provide for the suspension of the safe-harbor non-elective contributions and to provide that the regular non-discrimination tests will apply for the applicable plan year. Finally, the company must also make safe-harbor non-elective contributions in an amount based on the compensation of the plan participants through the date the suspension becomes effective.
The new regulations provide that any suspension of safe-harbor non-elective contributions will not be effective until the later of (i) thirty (30) days after the date that the participants are notified that the safe-harbor non-elective contributions have been suspended or (ii) the date that the plan amendment to provide for the suspension of the safe-harbor non-elective contributions is adopted. Therefore, if a company that sponsors a safe-harbor 401(k) plan believes that a “substantial business hardship” has occurred, it should consider immediately notifying the plan participants that the company intends to suspend the safe-harbor non-elective contributions and then adopt the plan amendment so as to limit the amount of the safe-harbor non-elective contributions that will need to be made for this plan year.
In light of the adoption of the new safe-harbor 401(k) plan regulations, LP recommends that companies which sponsor safe-harbor 401(k) plans that utilize safe-harbor non-elective contributions determine whether the company has suffered a “substantial business hardship” and, if so, decide whether to suspend the safe-harbor non-elective contributions in 2009. If the decision is made to suspend the safe-harbor non-elective contributions for 2009, the company should contact LP to draft the required plan amendment and participant notice.