During the economic downturn associated with the COVID-19 pandemic, some 401(k) plan sponsors may be considering a mid-year reduction or suspension of matching contributions or nonelective contributions to their 401(k) plans as a cost-saving measure. Generally, whether the matching or nonelective contributions may be reduced or suspended will depend on the specific terms of the plan. In addition, in the case of a plan that is intended to be a safe harbor plan under sections 401(k) or 401(m) of the Internal Revenue Code of 1986 as amended (the “Code”), the Code imposes particularly restrictive rules limiting mid-year changes. The following summarizes steps that a plan sponsor must take to reduce or suspend matching or nonelective contributions to its safe harbor plan during the plan year without jeopardizing the plan’s tax-qualified status.
In order for a plan to be a basic safe harbor plan under sections 401(k)(12) or 401(m)(11) of the Code or a qualified automatic contribution safe harbor plan under sections 401(k)(13) or 401(m)(12) of the Code, an employer must make a specified level of matching contributions, or alternatively, a specified level of nonelective contributions, to the plan. In addition, an employer must provide in advance of the plan year a “safe harbor notice” of the matching contributions or nonelective contributions, as applicable (but see SECURE Act change below), and the plan must satisfy certain vesting requirements. If these requirements are satisfied, the plan will be treated as satisfying the actual deferral percentage (ADP) and, with respect to matching contributions, the actual contribution percentage (ACP) nondiscrimination tests that normally apply to 401(k) plans. (We refer hereinafter to a 401(k) plan that is intended to satisfy the safe harbor rules as a “safe harbor plan,” and the matching contributions or nonelective contributions used to meet the safe harbor requirements as “safe harbor contributions.”)
To reduce or suspend safe harbor contributions to its safe harbor plan mid-year:
- Either (a) the plan sponsor must be operating at an economic loss for the plan year, or (b) the safe harbor notice provided prior to the beginning of the plan year to employees eligible to participate in the plan must have included a statement (i) that the plan may be amended during the plan year to reduce or suspend the safe harbor contributions, and (ii) that the reduction or suspension will not apply until at least 30 days after all eligible employees receive a supplemental notice of the reduction or suspension.
There is little guidance on how a plan sponsor can demonstrate that it is operating at an economic loss. Related IRS guidance makes clear that the existence of economic loss must be determined on the basis of the plan sponsor’s entire controlled group. Even though the relevant statute says there must be economic loss for the plan year, in the absence of guidance to the contrary, it would seem reasonable for a plan sponsor to look at losses year-to-date in determining that it has experienced economic loss. Beyond that, a plan sponsor should assemble the financial information evidencing the economic loss upon which the plan sponsor is relying and retain that financial information with the plan records.
- The plan sponsor must timely adopt a plan amendment that provides for the suspension or reduction of the safe harbor contributions to the plan.
Note that the reduction or suspension of safe harbor contributions cannot be effective until the date that is 30 days after the plan sponsor provides the supplemental notice to eligible employees (described in item 4 below) or, if later, the date that the plan amendment described above is adopted.
- The foregoing plan amendment must also provide that the plan will satisfy the ADP and ACP nondiscrimination tests for the entire plan year in which the suspension or reduction occurs, using the current year testing method. Of course, the plan must actually satisfy that requirement in operation.
- The plan sponsor must give all eligible employees a supplemental notice, in writing, at least 30 days in advance of suspending or reducing the safe harbor contributions. The supplemental notice must describe (a) the consequences of the plan amendment that reduces or suspends future safe harbor contributions, (b) the procedures the employees need to follow to change their elective deferral elections, and (c) the effective date of the plan amendment.
Note that The Setting Every Community Up for Retirement Enhancement (SECURE) Act eliminated, effective for plan years beginning after December 31, 2019, the requirement that employers provide a safe harbor notice prior to the beginning of the plan year about the employer’s intention to provide nonelective contributions. The SECURE Act did not, however, eliminate this requirement for plans intending to provide safe harbor matching contributions, or the requirement that the employer provide the supplemental notice if the employer reduces or suspends those nonelective contributions mid-year. Further, the SECURE Act did not eliminate (as a condition for reducing or eliminating nonelective or matching contributions mid-year) the requirement that the employer either (a) be operating at an economic loss or (b) have provided notice in advance of the plan year that the plan may be amended to reduce or eliminate matching or nonelective contributions, as applicable.
- The plan sponsor must give eligible employees a reasonable opportunity to change their elective deferral contributions prior to the date that the reduction or suspension of safe harbor contributions is effective (including a reasonable period of time to change their election after they have received the supplemental notice described above).
- The plan must satisfy the requirements for being a safe harbor plan for the period of the plan year that occurs prior to the date the safe harbor contributions are reduced or suspended, including satisfying the safe harbor compensation rules for determining the amount of safe harbor contributions that are nonelective contributions.
In addition to the foregoing rules that apply only to safe harbor plans, all tax-qualified retirement plans (including safe harbor plans) are subject to anti-cutback rules that prohibit plan sponsors from eliminating a benefit once a participant’s right to the benefit has accrued. The determination of whether a participant’s right to a matching contribution or other employer contribution has accrued before the end of the plan year, and therefore cannot be reduced or suspended during the plan year, will depend on the plan’s terms. Consequently, a plan sponsor must carefully review its plan’s terms in consultation with its legal counsel before suspending or reducing matching or other employer contributions mid-year, even if the plan is not intended to be a safe harbor plan.
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