Many employers searching for cost savings in the midst of the COVID-19 pandemic naturally have begun scrutinizing their contributions to benefits, such as retirement plans. The rules for making changes to retirement plan terms—and permit reductions in employer contributions—are complex, but new guidance temporarily permits you to reduce or suspend safe harbor contributions midyear.
Safe Harbor Retirement Plans
Under the rules governing qualified retirement plans (such as a 401(k) or 403(b) plans), contributions and benefits must not discriminate in favor of highly compensated employees (HCEs). Each year a plan must go through various tests for all participants, including the actual deferral percentage (ADP) test and the actual contribution percentage (ACP) test, which measure how evenly all employees are participating. In particular, the tests assess whether participation in the plan or benefits discriminates in the HCEs’ favor.
If a plan opts to be a safe harbor plan, however, it’s exempted from annual ACP and ADP testing. Safe harbor plans make either an annual matching contribution or nonelective employer contribution. The set amount is 3% of compensation, and it must be made on behalf of each eligible employee who isn’t an HCE.
Subject to certain requirements, a plan containing safe harbor contributions also may include contributions that aren’t safe harbor. For example, a safe harbor plan that makes an annual 3% nonelective employer contribution to non-HCEs may have a matching provision as well or offer more than 3% each year without compromising the safe harbor testing exemption.
A plan’s safe harbor status eases administrative complexity and allows plan sponsors to follow a set formula to ensure all employees are benefiting.
Midyear Reductions
Once a plan has adopted safe harbor matching or nonelective contributions, it may not make midyear changes that remove the safe harbor unless:
- The employer is operating at an economic loss for the plan year; or
- The plan included a statement in its annual notice (before the beginning of the plan year) that it may be amended during the plan year to reduce or suspend safe harbor matching contributions and that the reduction or suspension won’t apply until at least 30 days after all eligible employees receive notice of the change.
If your plan meets one of the criteria, then you may amend it midyear provided you send employees a supplementary notice of the safe harbor change. The change cannot be implemented until the later of the date of the amendment or 30 days after employees receive the supplemental notice.
The purpose is to give employees enough notice to change deferral elections based on the removal of a match or nonelective contribution. The plan also must be amended to provide that the ADP test will be satisfied for the entire plan year in which the reduction or suspension occurs using the current year testing method.
COVID-19-Permitted Midyear Reductions or Suspensions
On March 13, President Donald Trump issued an emergency declaration in response to the ongoing COVID-19 pandemic. The U.S. Department of the Treasury and the IRS have issued guidance postponing certain deadlines. For example, Notice 2020-51, which was released on June 23, extended the 60-day rollover period for certain distributions to August 31.
As the crisis has continued, financial challenges have prompted many employers to reduce or suspend contributions to retirement plans so they can meet payroll and other operating costs. Some employers are considering reducing contributions, removing safe harbor contributions, or cutting contributions to HCEs. Employers are questioning whether theses pandemic-related financial challenges satisfy the “economic loss” requirement in the rule to amend plans mid-year to remove safe harbors.
Employers also didn’t foresee the pandemic at the beginning of many plan years and therefore failed to include language about midyear changes required by the rule. Finally, the timing provisions for changes may be hard for employers to observe as they struggle through the pandemic.
To clarify all of the concerns, the DOT and the IRS issued temporary relief to employers clarifying that contributions made for HCEs aren’t included in the definition of safe harbor contributions. You can make midyear changes to contributions made on their behalf without breaking the safe harbor rules but must still provide them with an updated notice and election opportunity.
Additionally, the IRS provided employers with relief by allowing them to reduce or suspend safe harbor contributions midyear while retaining participant protections. Under the temporary measures, you may amend the plan to reduce or suspend safe harbor matching contributions or safe harbor nonelective contributions during a plan year if the amendment is adopted between March 13 and August 31.
Under that scenario, the plan won’t be treated as failing to satisfy the traditional requirements addressed above that the employer (1) is operating at a loss or (2) included notice before the plan year that the safe harbor might change and wouldn’t apply until 30 days after receiving notice.
Bottom Line
Currently, a plan can be amended midyear to remove the safe harbor without meeting the above requirements. If a plan is amended to remove a safe harbor nonelective employer contribution, however, it must provide a supplemental notice by August 31, and the amendment must be adopted no later than the effective date of the reduction or suspension of the safe harbor.
If a plan is reducing or suspending a matching contribution, it must still provide a supplemental notice allowing for implementation 30 days after you provide the notice.
Margaret Platzer is an attorney with Dinse P.C. in Burlington, Vermont. She can be reached at mplatzer@dinse.com.