3776 / Can an employer reduce or suspend 401(k) safe harbor nonelective contributions mid-year?

The IRS has issued final regulations that permit a safe harbor nonelective 401(k) plan to reduce or suspend safe harbor contributions mid-year if the plan contains a statement that such action is a possibility and the amendment does not become effective until 30 days after participants receive a supplemental notice of the mid-year amendment.¹

The IRS provided COVID-19 relief for safe harbor plan sponsors who acted by August 31, 2020. COVID-19 placed a strain on many business owners, making it difficult for some employers to keep up with mandatory employer matching contributions. Notice 2020-52 allowed plan amendments to reduce or suspend safe harbor contributions to non-highly compensated employees if they were made by August 31, 2020. The plan then became subject to nondiscrimination testing for the plan year.

If the safe harbor contributions being suspended or reduced were nonelective employer contributions (as opposed to matching contributions), the 30-day requirement for supplemental notice was satisfied if the notice was provided by August 31, 2020 and the amendment was adopted no later than the effective date of the suspension or reduction. If matching contributions were reduced or suspended, there was no relief from the 30-day requirement (to give employees time to decide whether to change their own elective contributions).

The IRS also clarified that contributions for highly-compensated employees are not safe harbor contributions—so they can always be reduced or suspended.²

In Notice 2016-16³, the IRS provided guidance on the safe harbor notice that must be provided to participants. The Notice also states that if it is not practicable for the revised safe harbor notice to be provided before the effective date of the change, the notice was considered to be timely if it was provided as soon as practicable, but not later than 30 days after the date the change was adopted. Notice 2016-16 also specified changes to safe harbor plans that cannot be made mid-year unless required by applicable law to be made mid-year, such as a change mandated by a law change or court decision.

Previously, an employer was only permitted to exit a safe harbor nonelective 401(k) plan if the employer was experiencing a substantial business hardship. Factors to be considered in making this determination included whether the employer was operating at an economic loss, general industry conditions and whether the employer would be able to continue the plan without eliminating the safe harbor contributions.

As a result of the new regulations, an employer is able to design its plan to provide the option of reducing or eliminating safe harbor nonelective contributions regardless of profitability. The regulations are retroactively effective and apply to plan years beginning after May 18, 2009.⁴

Finally, note that the annual participant notice requirements for nonelective contribution 401(k) safe harbor plans has been eliminated for plan years beginning after December 31, 2019 under the SECURE Act.⁵