New Treasury rule allows 401(k) flexibility for small businesses

By Staff Writer

Commentary May 22, 2009 at 08:00 PM

Share & Print

The U.S. Treasury is providing more flexibility to small businesses facing financial distress. New rules will allow those businesses to suspend contributions to safe harbor 401(k)s.

According to Bloomberg: "The rules, effective immediately, allow the companies to stop making payments to their so-called safe-harbor 401(k)s, without having to terminate the programs as previously required. Companies seeking the relief must show significant financial distress, such as the loss of money from low sales or a rise in health-care costs, the Treasury said in a statement today."

In safe-harbor 401(k) plan used often by small businesses, companies match employee contributions equal to 3 percent of annual compensation. The contributions are paid regardless of whether employees add their own money.

Companies with 250 employees or less have been faced with the option of liquidating their safe harbor 401(k)s as earnings deteriorate, according to Bloomberg. "When retirement plans are closed, employees get a lump-sum check that they can cash or roll into an Individual Retirement Account. In most cases, if they cash the check, they'll be subject to income taxes and a 10 percent tax penalty.

"If plans are terminated, employees don't have the opportunity to contribute their own money to the 401(k). Workers are then usually limited to $5,000 of tax-deferred savings a year for a traditional IRA rather than $16,500 per year permitted in a 401(k), according to IRS rules.

"About 1.7 percent of companies that offer 401(k) options use this type of safe-harbor plan, according to an annual survey by the Profit-Sharing/401k Council of America of 1,011 plans representing 7.4 million employees and $730 billion in assets."

NOT FOR REPRINT