Distressed employers allowed to reduce or suspend 401(k) or 403(b) non-elective contributions

In an effort to help businesses struggling through the current economic downturn, the IRS has issued regulations to allow employers experiencing significant business hardship to reduce or altogether suspend non-elective contributions to so-called safe harbor 401(k) or 403(b) (tax-sheltered annuity) plans. These proposed reliance regulations are designed as an alternative to employers terminating their plans.

Substantial business hardship

The option to reduce or suspend safe harbor non-elective contributions to a 401(k) or 403(b) plan is available to a business that would suffer a "substantial business hardship" if it were forced to continuing making the required contributions. The safe-harbor contribution levels ordinarily are set to avoid plan disqualification under tests to determine whether highly-paid employees receive too much of the benefits. These tests are commonly known as the ADP (actual deferral percentage) and the ACP (actual contribution percentage) tests.

The IRS will look at the following factors to determine hardship that allows suspension of contributions:

• Whether the employer is operating at an economic loss;
• Whether there is substantial unemployment or underemployment in the concerned trade or business and industry;
• Whether the sales and profits of the concerned industry are depressed or declining; and
• Whether it is reasonable to expect that the plan will be continued only if the funding relief is granted.

Relief requirements

The proposed regulations allow plans the option to suspend or reduce non-elective contributions. Employers electing non-elective contribution relief must meet the following requirements:

• Suffer a substantial business hardship;
• Provide a supplemental notice to all employees detailing the effect that reducing contributions will have, the effective date of the change, and the procedures employees need to follow to change their elections;
• Not reduce or suspend safe harbor non-elective contributions until 30 days after the later of the supplemental notice to employees or the amendment to the plan;
• Provide employees with a reasonable opportunity before the reduction of non-elective contributions to change their CODA election and employee contribution elections;
• Amend the plan to require that it satisfy the applicable nondiscrimination test for the year of the reduction; and
• Ensure that the plan satisfies the safe harbor matching contribution requirements for amounts deferred until the plan is amended.

Employers can start relying on the proposed regulations immediately as they are currently written until the IRS issues final regulations. The regulations are proposed to apply to plan amendments (to reduce or suspend contributions) adopted after May 18, 2009.

(NPRM REG-115699-09)