In response to the current economic crisis caused by COVID-19, many companies are considering cost-savings measures to improve their companies’ financial stability. One such cost-saving option is the reduction or suspension of company contributions to a company’s 401(k) or 403(b) plan. The procedure for and the implications of such suspension will depend on the plan terms, including whether the contribution is intended to be a “safe harbor” contribution.
Suspension of “Safe Harbor” Matching or Nonelective Contributions
Company contributions to a 401(k) or 403(b) plan can be structured to satisfy a safe harbor design for annual nondiscrimination testing purposes. Plans with a safe harbor design must satisfy various requirements, including the distribution of an annual notice to participants outlining the contribution structure and various other data elements. Plans that use a safe harbor design may be exempt from the actual deferral percentage (ADP) test (relating to elective deferrals under a 401(k) plan) and/or the actual contribution percentage (ACP) test (relating to company matching and employee after-tax contributions under a 401(k) or 403(b) plan). The ADP and ACP tests are intended to ensure that 401(k) and 403(b) plans do not unfairly benefit highly compensated employees (HCEs) at the expense of non-HCEs.
Safe harbor matching or nonelective contributions generally must remain in effect for an entire plan year. However, there are two key instances in which a company may reduce or suspend these contributions mid-year, either:
- When the safe harbor notice included a statement that the company reserved the ability to reduce or suspend safe harbor contributions mid-year
- Or when the company is operating under an economic loss
The following conditions must be met in both instances before a company can reduce or suspend safe harbor contributions:
- Plan participants must be provided with a supplemental notice explaining the change at least 30 days prior to the date on which the reduction or suspension will be effective.
- Plan participants must have a reasonable opportunity prior to suspension or reduction of safe harbor matching contributions to modify their deferral elections.
- A plan amendment must be adopted before the change is effective (ideally before the notice is sent).
- Company contributions must be made for periods prior to the effective date of the amendment to reduce or suspend contributions.
As a result of the reduction or suspension of safe harbor contributions, the plan will be subject to the ADP/ACP tests for the entire plan year in which the suspension occurred.
For safe harbor nonelective contributions, there is one additional nuance. The Setting Every Community Up for Retirement Enhancement (SECURE) Act eliminated the safe harbor notice requirement for plans using a safe harbor nonelective contribution formula effective for plan years on or after January 1, 2020. As a result, there is some uncertainty regarding application of the requirements outlined above for option #1 (suspension or reduction when certain content is included in the safe harbor notice), including the obligation to provide 30 days’ advance notice. However, the conservative approach in the absence of guidance is to follow the steps above when suspending or reducing any safe harbor contribution, whether matching or nonelective.
Suspension of Fixed or Discretionary Matching or Nonelective Contributions
When a plan has a fixed or discretionary non–safe harbor matching or nonelective contribution formula, a company has more flexibility to reduce or suspend company contributions. The 30-day advance notice requirement for a suspension of safe harbor contributions does not apply. However, companies should review the plan document and participant communications to see if there are any restrictions on suspending or reducing the contributions. A plan amendment will be required if there is a fixed contribution formula in the plan document. Depending on plan terms, the amendment may need to be made prospectively (e.g., for employees who have already accrued the right to all or a portion of the company contribution).
Although a plan with a non–safe harbor matching contribution formula is not exempt from the ADP/ACP nondiscrimination testing requirements, it is important to be aware that a suspension or reduction in contributions can impact testing. For example, a reduction or suspension in matching contributions may result in a decrease in contributions by non-HCEs. In a plan that historically had difficulty passing the nondiscrimination tests, it may be useful to have the recordkeeper perform mid-year testing to determine if there is a need to evaluate options to address testing concerns. If a plan fails one of the nondiscrimination tests, the excess deferrals or excess contributions made by or on behalf of HCEs must be corrected (such as by refunds or forfeitures).
There are a number of other nuances to be considered when suspending or reducing company contributions. For example, a reduction or suspension of company contributions may impact a company’s ability to rely on the coverage transition rule commonly applied after acquisitions. These considerations are beyond the scope of this blog post. We recommend contacting your Benefits and Executive Compensation attorney prior to suspending or reducing company contributions to a 401(k) or 403(b) plan to ensure that all relevant issues are considered.