Changing Times

During these trying economic times, I have received a constant stream of questions from advisers regarding various re-design options that may be available to plan sponsors with respect to their retirement plans. One of the most frequently asked questions (and most misunderstood options) involves whether it is permissible to reduce or suspend the employer safe harbor matching contributions, during a plan year, under a safe harbor 401(k) plan.

Safe Harbor Plans

By way of background, traditional 401(k) plans are subject to annual nondiscrimination testing to ensure that the average deferral rates of the highly compensated employees do not exceed the average deferral rates of the nonhighly compensated employees by more than (i) 125% or (ii) two percentage points and two times such deferral rates. If the average deferral rates of the highly compensated employees exceed the average deferral rates of the nonhighly compensated employees by more than the legally permitted percentage, then certain remedial steps must be taken.

To avoid having to perform the nondiscrimination tests and running the risk of having to return excess deferrals to the highly compensated employees, many plan sponsors redesigned their programs as safe harbor 401(k) plans. This type of plan mandates certain minimum employer contributions, imposes vesting/withdrawal restrictions, and requires an annual participant notice. If these conditions are met, the plan is deemed to have passed the nondiscrimination tests (i.e., no ADP/ACP tests are required). In general, a plan must be amended to be a 401(k) safe harbor plan prior to the beginning of the plan year and must retain such status for a least a 12-month plan year.

Plan Sponsor Options

So, what happens if an employer distributed its safe harbor notice in November 2008, announcing to employees that it would make an employer matching contribution equal to 100% of participant deferrals up to 4% of compensation (one approach to meeting the safe harbor 401(k) design requirements) and if the same employer now finds itself struggling to make payroll and to remain as a going concern? Is the employer locked into the 4% matching contribution for the entire plan year?

The good news is that the employer may prospectively reduce or suspend its matching contributions under a safe harbor 401(k) plan provided it undertakes all of the following:

1. distributes a written supplemental notice to all eligible employees;
2. ensures that the reduction or suspension of the safe harbor matching contribution is effective no earlier than 30 days after eligible employees are provided the notice or, if later, the date the amendment to reduce or suspend the match is adopted;
3. provides eligible employees a reasonable opportunity (including a reasonable period after receipt of the supplemental notice), prior to the reduction or suspension of safe harbor matching contributions, to change their deferral elections;
4. amends the plan document to provide that the nondiscrimination test will be satisfied for the entire plan year in which the reduction or suspension occurs using the current year testing method; and
5. makes sure that the plan satisfies all other safe harbor requirements with respect to amounts deferred through the effective date of the amendment.

In sum, although an employer may have intended to offer a safe harbor 401(k) plan to its employees and notwithstanding a previous announcement to its employees regarding its anticipated matching contribution for the current plan year, an employer has the option to reduce or suspend its contributions during the plan year. Even though the reduction or suspension of the employer contribution will necessarily transform the plan sponsor’s safe harbor 401(k) plan into a traditional 401(k) plan subject to nondiscrimination testing, this may be a welcome option (and, in some cases, a lifejacket) to plan sponsors who are facing budget cuts and layoffs.

Quana C. Jew is a partner at the law firm of Arent Fox LLP, focusing on ERISA, employee benefits, and executive compensation. Quana frequently serves as a guest lecturer in these areas for various law schools, bar seminars, and employee benefits-related organizations. Washingtonian magazine has repeatedly named Quana as one of Washington’s best tax lawyers.