IRS Revises Safe Harbor 401(k) Rules

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.”

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.