Compliance November 15, 2013

IRS Revises Safe Harbor 401(k) Rules

Revisions to the Internal Revenue Service’s (IRS) rules governing contributions to safe harbor 401(k) and 403(b) plans make it easier for struggling companies to reduce or suspend those payments.
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The rule changes impact non-elective and matching contributions paid by employers to safe harbor accounts, which are designed to allow employers to circumvent the most difficult non-discrimination standards for qualified retirement plans so long as they make certain minimum contributions to all eligible employees, among other stipulations.

In short, the changes ease interim regulations enacted in the wake of the 2008-09 financial crisis to provide struggling businesses a way to reduce or suspend non-elective contributions in the face of “substantial business hardship.”

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Before the IRS enacted the interim regulations, businesses had no way to reduce or eliminate non-elective contributions to safe harbor plans in the middle of a plan year. Matching contributions, though, could be cut or suspended at the mid-year point so long as 30-days’ notice was provided to plan participants.

The new rules, says Robert Kaplan, an associate attorney at Ballard Spahr LLP, are designed to alleviate confusion over what “substantial business hardship” actually entails. Under the new regulations, businesses can reduce or suspend safe harbor non-elective contributions at the mid-year point so long as they are operating at an economic loss and provide sufficient notice to employees.

“Before the new rules came out there was a bit of a problem, in that it was not clear exactly what a substantial business hardship was,” Kaplan tells PLANADVISER. “So only employers that were bankrupt or on the verge of going bankrupt felt comfortable using the provision. The new standard is more objective, because it’s obviously easier to determine if a company is operating at an economic loss than it is to say they have suffered a substantial hardship.” 

In addition to the new interpretation of substantial business hardship, the IRS has also merged the rules for reducing and suspending non-elective and matching contributions made to safe harbor plans. The interim regulations previously only demanded companies warn employees before cutting matching contributions halfway through a plan year.

Starting January 1, 2015, companies will have to be operating at an economic loss in order to suspend matching contributions at a plan year’s midpoint—the same standard applied for cutting non-elective contributions.  

Kaplan says one other change included in the revisions will likely have the widest impact on employers utilizing safe harbor plans to avoid onerous non-discrimination testing, as it applies to businesses not suffering economic hardship.

Put simply, the IRS wrote a caveat into the final regulations that will allow plans to cut both non-elective and matching contributions midway through a year even if they are not suffering economic hardship, so long as they warn participants that they are reserving the right to do so in the plan’s annual safe harbor notices.

“Even if a business doesn’t think it’s going to actually enact a reduction or suspension at mid-year, it still makes sense for them to put in this caveat,” Kaplan says. “We are expecting a lot of plans to start filtering in this language over the next year.”

More on the text of the regulatory changes is available here. 

The Markets November 15, 2013

October Shows Some Above-Normal Transfer Volumes

The Aon Hewitt 401(k) Index showed six days of above-normal daily transfer activity during the month of October.
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These days of heavy activity took place on October 7, 8, 9, 17, 18 and 21. The high volumes coincided with the timing of lawmakers’ negotiations on the government shutdown and debt ceiling. Through the month, daily transfer activity averaged 0.035% of total account balances per trading day. The monthly average was moderately above the trailing 12-month daily average, at 0.030%.

The index defines a normal level of relative transfer activity as when the net daily movement of participants’ balances, as a percent of total 401(k) balances within the index, equals between 0.3 times and 1.5 times the average daily net activity of the preceding 12 months.

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October began with investors focused on the government shutdown and concerns about a potential government default should the debt ceiling not be raised, according to the index. Late in the day on October 16, Congress reached a deal to reopen the government and raise the debt ceiling. This deal, combined with the speculation that the Federal Reserve may further delay any plans to start tapering its bond-buying program, had a positive impact on capital market results for the month.

Large U.S. equities, as measured by the S&P 500 Index, gained 4.6% during the month. Small U.S. equities, as measured by the Russell 2000 Index, gained 2.5%. Interest rates continued to decline, since rising in early September, with the yield of the 10-year Treasury falling to 2.57% at the end of the month. The Barclays Aggregate ended October in positive territory, rising 0.8% for the month. Positive news from Italy, the UK, Asia, the Czech Republic and China helped bolster international equities. The MSCI EAFE Index and MSCI Emerging Markets Index posted October returns of 3.4% and 4.9%, respectively. Commodities were the worst-performing asset class in October, negatively impacted by falling oil prices.

In October, 61% of the trading days favored equities instead of fixed-income investments. The first seven trading days of the month moved toward fixed income at an accelerated rate. Transfers then reversed direction toward equities after October 9, with the exception of two trading days.

Net transfer activity for October heavily favored diversified equities (equity assets excluding company stock) with $384 million (0.26%) flowing in. Total activity across the Aon Hewitt 401(k) Index was moderate with $428 million transferring for the month.

Outflow activity was led by company stock funds, with $143 million (33%) transferring out, and also by GIC/stable value funds, with $141 million (33%) transferring out. In addition, bond funds had $100 million (23%) of outflows, and premixed funds decreased by $30 million (7%).

Net inflows for October were led by large U.S. funds, which received $141 million (33%) from flows. International funds received $127 million (30%). Both small U.S. funds and mid-sized U.S. funds also had increases, each with $102 million (24%) and $41 million (10%) of inflows.

Employee discretionary contributions, another measure of participant sentiment, increased to 65% in equities for October, up slightly from 64.9% in September.

Finally, the index showed that as markets rallied and transfer activity favored equities, participants’ average equity allocations reached 64.1% by the end of October, up from 63.3% at the beginning of the month.

More information about the Aon Hewitt 401(k) Index for October can be found here.

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