The economic crisis caused by the COVID-19 virus is forcing many businesses to look for cost-savings measures to improve their financial situation or, in some cases, to survive. Some businesses have laid off or placed employees on standby unemployment benefits. Others are looking for creative ways to reduce costs to keep employees on the payroll. Some businesses are considering whether they can save costs by reducing or suspending company contributions to their 401(k) plan. Given the complex federal laws that control benefit plans, many clients facing unforeseen financial issues have asked, “Is it even possible to change our plan in the middle of a plan year?” The answer depends on whether your business has a “safe harbor” plan and your plan’s specific terms.
Safe harbor plans are designed to avoid annual testing under nondiscrimination rules that are designed to prevent favored treatment of highly compensated employees. Safe harbor plans avoid the prospect of failing the nondiscrimination testing and the need to return elective deferrals to highly compensated employees. Because these “safe harbor” plans must comply with numerous regulatory requirements, it is more difficult to reduce or suspend contributions to safe harbor plans during a plan year. On the other hand, plans that are not safe harbor plans are generally free to make mid-year changes unless the specific terms of the plan restrict such changes.
Sponsors of non-safe harbor plans can generally reduce or suspend company contributions — matching or “nonelective” contributions — during the plan year simply by adopting an amendment. If the company contributions are discretionary, it may not even be necessary to amend the plan; a board resolution may be sufficient. However, some non-safe harbor plans provide for a fixed employer contribution. In that case, if employees have already met the eligibility conditions to receive those contributions for the year, the company may not be able to reduce or suspend contributions, at least with respect to the first part of the year. For example, if the plan uses a fixed formula (e.g., four percent of compensation) and employees are not required to work certain hours to receive a share of the contribution, the contribution might be suspended only prospectively.
Of course, suspending or reducing the company’s contributions to the plan mid-year could impact nondiscrimination testing. For example, highly compensated employees may “front load” their elective deferrals in a 401(k) plan, perhaps by deferring a percentage of their bonuses. In this case, the plan could fail the nondiscrimination tests at year-end, forcing the plan to return some or all of those deferrals to highly compensated employees.
Importantly, the Internal Revenue Code does not require your business to decide whether to make a discretionary contribution to a plan until after the end of the year (assuming the plan permits it), and the contribution can be made by the (extended) due date of the company’s tax return for the year. For this reason, if your business currently faces a dire financial situation, but you expect to recover quickly once COVID-19 restrictions are lifted, you may want to keep your options open and decide early next year whether to make a contribution and how much.
Generally, safe harbor matching or nonelective contributions cannot be reduced or suspended mid-year; however, this is subject to two important exceptions if your business:
If one of the two exceptions applies, your business must:
Important changes made by the SECURE Act may modify or eliminate some of these requirements beginning in 2020, but we are awaiting IRS guidance on the new law. Until guidance is issued, we recommend that businesses follow the pre-2020 rules regarding reduction or suspension of contributions.
Remember that when a company reduces or suspends its safe harbor contributions, the plan becomes subject to the nondiscrimination testing requirements for the entire plan year. If the plan fails these tests, highly compensated employees may have some of their contributions returned.
If your business wants to consider a mid-year reduction or suspension:
For more information, consult Lane Powell’s COVID-19 Resource Center or contact Katheryn Bradley.
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