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Definition of Compensation When Safe Harbor Match Eliminated Mid Year

“The company is a safe harbor 401(k) match plan and they pay the match in a lump sum after the plan year.  The company amended the plan to remove the safe harbor matching contribution mid-year. What definition of compensation should the plan use to determine the amount of match to make—full year or partial year?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Ohio is representative of a common inquiry related to the definition of compensation.

Highlights of the Discussion

The IRS has provided guidance in treasury regulations  as follows.

“A plan that is amended during the plan year to reduce or suspend safe harbor contributions (whether nonelective contributions or matching contributions) must pro rate the otherwise applicable compensation limit under section 401(a)(17) in accordance with the requirements of § 1.401(a)(17)–1(b)(3)(iii)(A).”

Consequently, when a safe harbor 401(k) reduces or suspends the matching contribution mid-year via amendment, the plan would use prorated compensation to determine the amount of match to make for the shortened period of time the match is given.

However, because the plan is no longer a safe harbor plan, it must be amended to provide that the actual deferral percentage (ADP) test and actual contribution percentage (ACP) tests will be satisfied for the entire plan year in which the reduction or suspension occurs using the current year testing method described in §1.401(k)–2(a)(2)(ii).  Therefore, the plan would be required to use full year compensation to run the ADP and ACP tests [see Treas. Reg. Sections 1.401(k)-3(g)(1)(iv) ].

Conclusion

Using the correct definition of compensation for plan purposes is one of the top compliance concerns of the IRS. This hurdle is confounded even further when plans realize more than one definition of compensation may apply depending on the circumstance.

 

 

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Reducing or Suspending 401(k) Safe Harbor Contributions Mid-Year

“My client is a business owner and has a standard 401(k) safe harbor plan.  Under what circumstances, if any, may he reduce or eliminate the company’s mandatory safe harbor contribution during the plan year?”   

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Washington is representative of a common inquiry related to 401(k) safe harbor plans.

Highlights of the Discussion

Under limited circumstances, and according to final Treasury Regulations, a sponsor of a 401(k) safe harbor plan may amend the plan during the current year to reduce or suspend the company’s safe harbor contribution—either the matching or nonelective contribution.

A removal or reduction of a safe harbor contribution mid-year is permitted if the employer either

  1. Is operating under an economic loss for the year (See Internal Revenue Code Section (IRC 412(c)(2)(A);

or

  1. Included a statement in the safe harbor notice given to participants before the start of the plan year that the employer
  • May reduce or suspend contributions mid-year;
  • Will give participants a supplemental notice regarding the reduction or suspension; and
  • Will not reduce or suspend employer contributions until at least 30 days after receipt of the supplemental notice.

Supplemental Notice

If a reduction or suspension will occur, the supplemental notice must explain 1) the consequences of the suspension or reduction of contributions; 2) how participants my change their deferral elections as a result; and 3) when the amendment takes effect.

Other Procedural Requirements

The employer must also

  1. Give participants a reasonable opportunity after they receive the supplemental notice and before the reduction or suspension of employer contributions to change their contribution elections;
  2. Amend the plan to apply the actual deferral percentage (ADP) and/or actual contribution percentage (ACP) Tests for the entire plan year; and
  3. Allocate to the plan any contributions that were promised before the amendment took effect.

Conclusion

With the proper set up, or as a result of economic loss, sponsors of 401(k) safe harbor plans may reduce or suspend employer matching or nonelective safe harbor contributions mid-year.

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Mid-Year Changes to Safe-Harbor 401(k) Plans

“What changes, if any, can an employer make to a safe harbor 401(k) plan during the plan year, while maintaining safe harbor status?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Washington D.C. is representative of a common inquiry related to making changes to a safe harbor 401(k) plan.

Highlights of Discussion

Sponsors of safe harbor 401(k) plans[1] have a limited ability to alter their plans mid-year without jeopardizing their safe harbor status. Any change must be one the IRS views as “permissible” and, oftentimes, employees must receive notification and have a new deferral election opportunity.

Notice 2016-16 provides that a mid-year change to a safe harbor plan or to a plan’s safe harbor notice does not violate the safe harbor rules merely because it is a mid-year change, if the

  • Plan satisfies the notice and election opportunity conditions, if applicable, and
  • Change is not a prohibited mid-year change as listed in Notice 2016-16.Permissible Changes
  • According to the notice, permissible mid-year changes include
  1. Increasing future safe harbor non-elective contributions from 3% to 4% for all eligible employees;
  2. Certain increases to matching contributions adopted at least three months before the end of the plan year;[2]
  3. Adding an age-59 ½, in-service withdrawal feature;
  4. Changing the plan’s default investment fund;
  5. Altering the plan rules on arbitration of disputes;
  6. Shifting the plan entry date for employees who meet the plan’s minimum age and service eligibility requirements from monthly to quarterly; and
  7. Adopting mid-year amendments required by applicable law (for example, newly effective laws).

Changes 1-4 require an updated notice and an additional election period as explained next.

Notice Requirements

When required, sponsors must provide an updated safe harbor notice that describes the mid-year change and its effective date within a reasonable period before the effective date of the change. Providing the notice 30-90 days before the effective date is deemed reasonable. If is it not possible for the plan sponsor to distribute the updated safe harbor notice before the effective date of the change, it must provide the notice as soon as practicable, but not later then 30 days after the date the changes is adopted.

Election Requirement

When required, sponsors must give each notified employee a reasonable period of time to change his or her cash or deferral election after receipt and before the effective date of the change. A 30-day election period is deemed reasonable. However, if it is not possible to provide the election opportunity before the effective date of the change (e.g., retroactive plan amendment), then the election opportunity must begin as soon as practicable after the notice date, but not later than 30 days after the date the change is adopted.

EXAMPLE Plan M:

  • Traditional 401(k) matching safe harbor plan
  • Operated on a calendar year
  • Match is calculated on a per payroll-period basis
  • A mid-year amendment is made August 31, 2018, to 1) increase the safe harbor matching contribution from 4% to 5%; and 2) change from a payroll-period match to a full-plan-year match
  • Both changes are retroactively effective to January 1, 2018

Due to the retroactive effective date of the change, the sponsor cannot provide an updated notice and give an additional election opportunity to employees prior to the January 1, 2018, effective date. On September 3, 2018, the first date that an updated notice and additional election opportunity can practicably be provided, the sponsor distributes an updated notice that describes the increased contribution percentage and gives an additional 30-day election period starting September 3, 2018. The mid-year change is a permissible change, and notice and election requirements are met.

Conclusion

Sponsors of safe harbor plans often wonder if they can make changes to their plans mid year. The answer is yes, provided any change is of the permissible variety, and notice and election requirements are met.

 

[1] IRC §§ 401(k)(12) or 401(k)(13) and/or 401(m)(11) or 401(m)(12), and 403(b) plans that apply the IRC § 401(m) safe harbor rules pursuant to IRC § 403(b)(12).

[2] Adopted at least three months before the end of the plan year, made retroactively effective, revocation of payroll period allocation, and new notice and election period apply.

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