The IRS on Jan. 29 provided some long-awaited guidance on which midyear amendments to “safe harbor” 401(k) retirement plans it will allow — and which remain prohibited. The guidance, effective immediately, should put to rest years of confusion among practitioners over when they can adjust plans to reflect short-term changes without putting their plan’s qualification at risk.
The federal tax Code normally allows plan changes only at 12-month intervals. IRS Notice 2016-16, however, outlines several routine changes to plans that may be made midyear without violating the Code, if appropriate participant election and notice periods are given. The new notice revokes IRS Announcement 2007-59 on the same topic.
Safe harbor 401(k) plan designs started with the 1999 plan year to help avoid costly and time-consuming nondiscrimination testing of all plan participants. Among other features, safe harbor plans are based on specified matching or employer contributions. By using these safe harbors, the plan sponsor can eliminate the need to test every single employee under the actual deferral percentage test applicable to employee deferrals and the actual contribution test applicable to employer matching contributions.
In return for avoiding the tests — and the potential limits or reductions on highly compensated employees’ 401(k) benefits — the plan must offer either matching contributions of up to 4 percent of compensation, or nonelective employer contributions of 3 percent of compensation, for all nonhighly compensated employees.
Changes Now Allowable at Midyear
Typical routine changes now allowable during the year, for which plan sponsors long have been seeking IRS clearance, include a minor adjustment to an employer matching amount or a switch in the default investment fund in the plan. Up to now, plan sponsors had to wait a full 12 months to effect such changes.
At the same time, the notice outlines the following changes that remain prohibited at midyear:
- an increase in the number of completed years of service required for an employee to have a nonforfeitable right to his account balance under qualified automatic contribution arrangements;
- a reduction or narrowing of the group of employees eligible to receive safe harbor contributions;
- a switch in the type of safe harbor plan, such as moving from a traditional 401(k) safe harbor plan to a QACA safe harbor plan; and
- a modification in, or addition of, a formula used to determine matching contributions, if the change increases the amount of the matching contributions.
The notice includes several examples that plan sponsors and their service providers may review to put the new guidance into practice.
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