As the economy continues to struggle, practitioners have been besieged with questions regarding how employers can reduce or eliminate retirement plan contributions. In the FAQs below, we address how an employer can eliminate or freeze fixed contributions under a safe harbor 401(k) plan.

1. May an employer freeze a safe harbor 401(k) plan mid-year or, in the alternative, amend it into a traditional 401(k) plan mid-year?

An employer may freeze or amend mid-year a safe harbor 401(k) plan which provides a safe harbor matching contribution (basic or enhanced) formula, in order to reduce or eliminate future safe harbor matching contributions. However, an employer may not freeze or amend mid-year a safe harbor 401(k) plan which uses the safe harbor nonelective contribution formula. The only way to eliminate the safe harbor nonelective contribution mid-year is to terminate the plan.

2. What are the necessary steps to freeze or amend mid-year a safe harbor 401(k) plan which provides the safe harbor matching contribution?

The plan must apply the following steps to freeze or amend mid-year a safe harbor 401(k) plan:

1. Provide a notice of the plan change to the employees at least 30 days before the effective date of the amendment to reduce or eliminate the match;
2. Provide the employees a reasonable opportunity to change their deferral election;
3. Adopt an amendment to reduce or eliminate the matching contribution formula, effective at least 30 days after the amendment’s adoption date;
4. Fund the match through the date of the amendment; and
5. Apply current year testing for the entire year for both the ADP and ACP tests.

Note: The safe harbor matching contributions will qualify as qualified matching contributions and therefore, the employer may use the contributions in the ADP test.

Example: LTD maintains a safe harbor 401(k) plan with an enhanced safe harbor matching contribution formula of 100% of elective deferrals not exceeding 4% of compensation. In March 2009, LTD determines it cannot afford the match. On March 15th, LTD adopts an amendment eliminating the safe harbor match effective April 14, 2009, and provides a notice that it has amended the matching formula to eliminate the safe harbor match and to provide for a discretionary match. The employees may change their deferral election at any time. LTD funds the match through April 14, 2009. Using current year testing, LTD applies the ADP and the ACP test for the entire year.

Example: LTD maintains a safe harbor 401(k) plan with a 3% safe harbor nonelctive contribution formula. In March 2009, LTD determines it cannot afford the nonelective contribution. LTD wishes to convert the formula to a discretionary profit sharing formula. Unless LTD wishes to terminate its plan, the effective date of the change cannot occur before the beginning of the 2010 plan year.

3. May a safe harbor 401(k) plan with a safe harbor matching contribution formula and an additional matching contribution formula (discretionary or fixed) that is intended to qualify under the ACP safe harbor (ACP safe harbor match) eliminate or amend the ACP safe harbor match? May a safe harbor 401(k) plan eliminate or amend the ACP safe harbor match and not the safe harbor matching contribution formula that enables the plan to satisfy the ADP test safe harbor?

The regulations do not specifically address the elimination or amendment of the ACP safe harbor match. However, we do not see any reason why the employer should not also be able to eliminate or amend the ACP safe harbor match. We also feel that a safe harbor 401(k) plan should be able to eliminate or amend an “additional” ACP safe harbor match even if it is not amending or eliminating the safe harbor match that enables the plan to satisfy the ADP test safe harbor. However, to qualify for the ACP safe harbor, all matches generally must satisfy the safe harbor requirements for the entire plan year. Therefore, the mid-year elimination or amendment of the ACP safe harbor match would mean the plan would need to apply the ACP test to all of the matching contributions for the plan year, including the ADP safe harbor match. The plan would continue to qualify for the ADP safe harbor as long as the employer did not amend the ADP safe harbor matching formula. As a precaution, when amending the ACP safe harbor match, we would recommend following the same steps as the plan would apply in eliminating or amending an ADP safe harbor match.

4. For an employer that wishes to retain flexibility over the safe harbor nonelective contribution, what plan design options are available?

An employer may use the “maybe” notice approach with the safe harbor nonelective contribution formula. Under the maybe notice approach, the employer has until 30 days before the end of the year to decide to provide the safe harbor nonelective contribution, and thereby become a safe harbor plan for the plan year.

5. What steps must the employer follow to apply the “maybe” notice approach?

The employer must follow the following steps in to apply the “maybe” notice:

1. Maintain a 401(k) plan;
2. Provide a notice to the employees before the beginning of the year indicating that the employer may provide a safe harbor nonelective contribution;
3. If it decides to be a safe harbor 401(k) plan, provide a supplemental notice at least 30 days before the end of the plan year indicating that it will make a safe harbor nonelective contribution; and
4. Amend the plan to provide a safe harbor nonelective contribution.

6. May an employer apply the “maybe” notice for more than one plan year?

Yes. The employer may apply the “maybe” notice approach indefinitely. An employer that gives the supplemental notice can avoid a subsequent additional amendment to “undo” the safe harbor nonelective contribution for the next plan year by indicating in the amendment that it applies only for the plan year in which the employer gives the supplemental notice.

7. May an employer terminate a safe harbor 401(k) plan mid-year?

An employer may terminate a safe harbor 401(k) plan mid-year irrespective of whether the plan uses the safe harbor nonelective contribution or the safe harbor matching contribution formula.

8. What steps must the employer follow to terminate a safe harbor 401(k) plan?

Assuming the employer does not terminate the plan on account of a “substantial business hardship” or an “acquisition transaction” (see the next FAQ), the employer must follow the following steps to terminate a safe harbor 401(k) plan:

1. The employer must provide a 30-day notice to employees informing them that it intends to terminate the plan;
2. Fund the safe harbor contribution through the termination date; and
3. Apply the ADP and ACP tests using current year testing.

Note: The safe harbor nonelective contributions will qualify as qualified nonelective contributions, and therefore the plan may use the contributions in the ADP or ACP tests.

Example: LTD maintains a safe harbor 401(k) plan with a 3% safe harbor nonelective contribution formula and a discretionary matching formula which meets the requirements of the ACP safe harbor. In March 2009, LTD determines it cannot afford the nonelective contribution. LTD wishes to terminate the plan. LTD provides a 30-day notice on March 15, 2009 that the plan will terminate as of April 14, 2009. LTD must fund the safe harbor contribution through the termination date. The plan will need to apply the ADP and ACP tests for the 2009 plan year.

9. May an employer terminate a safe harbor 401(k) plan and retain safe harbor status for the short plan year?

Yes. If the employer terminates the safe harbor 401(k) plan because: (1) the employer incurs a substantial business hardship that satisfies the pension plan funding waiver requirements, or (2) the employer is involved with an acquisition or disposition that satisfies the requirements of Code §410(b)(6)(C), the plan continues to qualify for safe harbor status for the short plan year in which the plan terminates. The regulations do not impose an advance notice requirement to terminate a safe harbor 401(k) plan under either of these two circumstances.

Example: SNA acquires the stock of LTD as of June 1, 2009. LTD terminates its safe harbor 401(k) plan as of the date of the acquisition. LTD funds the plan through the date of the termination. The plan is a safe harbor 401(k) plan for the short plan year since it terminates because of an acquisition transaction.

10. What factors must an employer use to determine if it has incurred a substantial business hardship?

The employer should consider the following factors in determining whether it has incurred a substantial business hardship:

1. The employer is operating at an economic loss;
2. There is substantial unemployment or underemployment in the trade or business and in the industry; and
3. The sales and profits of the industry concerned are depressed or declining.

Retirement Plans in a Troubled Economy
SunGard Relius will present a one-day seminar in which it will address the numerous issues practitioners are confronting in these difficult economic times, including eliminating or reducing a safe harbor contribution formula. For more information on the topics covered in this timely course and registration information, go to our seminar web page