IRS Publishes Proposed Regulations to Allow Suspension or
Reduction of 401(k)/403(b) Safe Harbor Nonelective Contributions

      On May 18, 2009, the Internal Revenue Service published proposed regulations to permit employers that incur a substantial business hardship to suspend or reduce safe harbor nonelective contributions during a plan year.  The proposed regulations affect safe harbor 401(k) plans and safe harbor 403(b) plans that satisfy the safe harbor rules by making a safe harbor nonelective contribution.

      Prior to the proposed regulations, an employer could not change the safe harbor nonelective contribution mid-year after committing to the contribution through its safe harbor notice to employees.  This meant the rules for changing safe harbor nonelective contributions were far more restrictive than the rules for changing safe harbor matching contributions, which could already be suspended or reduced midyear.

      Substantial Business Hardship.  Under the proposed regulations, employers are permitted to suspend or reduce safe harbor nonelective contributions midyear if they incur a substantial business hardship.  Factors taken into account in determining whether an employer has incurred a substantial business hardship include, but are not limited to:

• 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 nonelective contribution can be suspended or reduced.

      Other Requirements.  In addition to incurring a substantial business hardship, employers must also satisfy requirements similar to those already in place for midyear changes to safe harbor matching contributions.

• Supplemental Notice.  Eligible employees must be provided with a supplemental notice that explains the consequences of the amendment that reduces or suspends future safe harbor nonelective contributions, the procedures for changing employee contribution elections, and the effective date of the amendment.

• Effective Date.  The reduction or suspension of the safe harbor nonelective contribution can occur no earlier than 30 days after the supplemental notice is provided to employees, or the date the amendment is adopted, if later.

• Opportunity to Change Contribution Elections.  Eligible employees must be given a reasonable opportunity to change their contribution elections prior to the reduction or suspension of the safe harbor nonelective contribution.

• Satisfy ADP and ACP Tests.  The plan must be amended to provide that the actual deferral percentage test and actual contribution percentage test (the nondiscrimination tests that apply to employee deferrals and employer matching contributions, respectively) will be satisfied for the entire plan year.

• Pay Nonelective Contribution Through Effective Date.  The safe harbor nonelective contribution requirement must be satisfied with respect to compensation paid through the effective date of the amendment.

      While the regulations are still in proposed form, employers may rely on them for guidance pending the issuance of final regulations.  If the final regulations are more restrictive than the proposed regulations, those provisions of the final regulations will be applied without retroactive effect.

      These proposed regulations provide an opportunity for employers who are suffering a substantial financial hardship to reduce or eliminate their 401(k) and 403(b) safe harbor nonelective contributions.  This provides a viable alternative to complete plan termination for these employers.  The proposed regulations may be found here.

      For more information about the proposed regulations or assistance in suspending or reducing safe harbor nonelective contributions, please contact Craig Burke, Jim Kemper, Melissa Proffitt Reese, Marc Sciscoe, Tara Sciscoe, Christopher Sears or your Ice Miller LLP employee benefits attorney.