Small to mid-size professional service firms are currently scrambling to re-adjust their budgets due to the economic disruption of coronavirus restrictions. As a result, 401(k) providers such as myself have been fielding many questions recently from plan sponsors who are asking whether safe harbor contributions may be suspended and what other considerations should be considered prior to moving forward.
Unlike many other aspects of the rules governing qualified plans such as 401(k), the answer to the first question is fairly simple. The IRS does allow plan sponsors to amend their plan documents mid-year to suspend a company’s safe harbor contributions. But there are some caveats as listed below. This would be true whether your plan uses the safe harbor non-elective or one of several qualifying safe harbor matching formulas.
That is the easy part. The considerations that must factored prior to making this decision are more complex. My objective here is to clearly lay out these issues as they apply to safe harbor plans in general. My objective here is to give you an aerial view of the factors that come in to play for mostplans. Because the details of your plan document are critical, plan sponsors should consult with your TPA and other plan providers prior to moving forward.
Removing Safe Harbor
In order to suspend employer contributions, plan sponsors must first amend the plan document to remove the safe harbor provision. The rules require that a supplemental notice be given to all eligible employees not less than 30 days prior to the change.
There are a few contingencies, however, that must be considered:
- Participants must be allowed to change their deferrals prior to the change becoming effective.
- The employer must have included in the annual safe harbor notice a statement that the plan could be amended mid-year to reduce or suspend safe harbor contributions – or –provide evidence that they would be operating at an economic loss. Employers and related employers in the same controlled group would need to show that expenses exceed income for the year based on generally accepted accounting principles.
- The suspension cannot be effective for at least 30 days after the later of the supplemental notice or the effective date of the plan amendment.
- An employer who suspends or reduces its safe harbor mid-year must pay the safe harbor contribution amount from the beginning of the plan year up to the effective date of the change. The annual compensation limit used to calculate the safe harbor contribution would be pro-rated up to the date of suspension.
There are, however, some really, really important caveats that must be considered to avoid some unintended consequences for employers.
Year to Date Contributions
Employers who suspend contributions mid-plan year are not relieved of the duty to fund safe harbor contributions for the period from the beginning of the plan year through the date the safe harbor suspension becomes effective. For example, if an employer provides notice on May 1, 2020, the safe harbor contribution will be calculated on eligible wages and deferrals through May 30, 2020.
But for businesses who expect cash flow to return to pre-virus levels, there is some good news. Employers are able to minimize the impact of required contributions by postponing deposit deadlines. In order for your contribution to be tax deductible, the deposit must be made by the due date, with extensions, of your company’s tax return. For a company operating on a calendar tax year ending December 31, 2020,the deposit deadline could be as late as October of 2021. If you are not concerned about claiming the tax deduction, you would have up until December 31, 2121 to deposit the 2020 contributions.
If your plan calculates your contributions on some period other than a full year, e.g. per pay period or per quarter, the deposit deadline is accelerated to the end of the quarter following the quarter in which the match accrues. That means contributions accrued through June 30, 2020 would have to be deposited no later than September 30, 2020.
One final caveat should be considered for extending contribution deadlines. If your plan specifies that the match is to be based on annual compensation and deferrals but operationally chooses to make deposits each pay period, it would qualify as an annual match subject to the former extended deposit deadlines.
If you currently have a pay period match, you can amend your document to provide for an annual match in order to have more time to make the required deposits. Keep in mind this change must be retroactive to the beginning of your plan year. This may result in true-up amounts for any participant who may have front loaded their deferrals. This can be tricky, so make sure you review your plan documents and year to date deferrals with your TPA.
Loss of Top-Heavy Exemption
It is important to realize that a plan that elects to suspend safe harbor is now subject to top heavy rules. In order to avoid punitive top heavy provisions, the aggregate value of the assets of key employees must not exceed 60% of the total assets of the plan. If key employees have been contributing during the year, this could result in a required contribution equal to 3% of wages for all non-key employees. On the other hand, if no key employees have deferred into the plan or received employer contributions year to date, the minimum required contribution is zero.
Since the goal for most employers who wish to suspend safe harbor contributions is to reduce employer costs, a review of year-to-date contributions and a plan’s top heavy status is a crucial step in the decision making process. You may find that suspending contributions would be significantly offset by these addition payments to all eligible, non-key employees. You might be better off canceling your free gym memberships!
However, employers who are required to make these top heavy contributions would have until their tax filing date or extension (e.g. April 15 or October 15, 2020) to make a deposit in order to claim the contributions as a tax deduction, or by December 31, 2020 to simply comply.
ADP/ACP Testing
Plan sponsors who elect to suspend safe harbor provisions mid-year will additionally be subject to ADP/ACP non-discrimination testing. Depending on how early in the year the suspension becomes effective, plans should have more flexibility to avoid corrective distributions by limiting or controlling the deferrals made by highly compensated employees from that point thru year end. Corrective refunds, should they be necessary, create additional administrative costs and complexity for plans and should be factored in to this decision.
Reinstatement of Safe Harbor Provisions
For plans with safe harbor provisions based on tiered or match formulas, the current rules do not allow plan sponsors to reinstate to be effective within the same plan year . However, these matching options can be amended not less than 30 days prior to year-end to be effective January 1 of following plan year.
However, the passage of the SECURE Act has given employers additional flexibility to reinstate non-elective safe harbor provisions during the current plan year. It is even possible under provisions of the bill to establish non-elective safe harbor provisions to the plan after year end.
That means plan sponsors are allowed amend their plan documents to remove safe harbor provisions now and should their financial situation improve, amend again to retroactively add back the safe harbor provision for 2020 provided they do so by December 3, 2021.
Unchartered Territory
Let’s face it. Plan sponsors and their providers are navigating uncharted territory with current economic uncertainty and regulatory changes. I have attempted to outline some of the general considerations and consequences of a decision to suspend safe harbor contributions.
Although not a prediction, it would not be surprising to see future rule changes that may impact these decisions. Plan sponsors should be advised to consult your TPA and ERISA attorney for specific guidance based on your current situation and further consider the potential costs and contingencies that would result from a potential suspension of safe harbor contributions.
Brian C. Rall
President-Strategic Retirement Partners, LLC
April 29, 2020
Strategic Retirement Partners is an independent, boutique investment advisory and consulting firm providing plan design, vendor search, investment selection, fiduciary guidance and participant education for company sponsored retirement plans.
Strategic Retirement Partners, LLC is a registered investment advisor in the State of Washington. The investment advisor may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Any information contained herein or on SRP’s website is provided for educational purposes only and is not intended to make an offer or solicitation for the sale of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated are not guaranteed. SRP does not provide legal or tax advice and clients should consult their attorneys and CPA for any strategy discussed herein or on this website.
