Since the spread of the coronavirus began to curtail business operations in March, many employers have been looking for ways to reduce their operating expenses. Among those options considered most frequently has been a suspension or reduction in employer contributions to retirement plans. For those employers that maintain “safe harbor” 401(k) or 403(b) plans, however, the matter was not as easy as simply adopting a plan amendment. In fact, many employers discovered that existing IRS rules made it difficult, if not impossible, to change their plans prior to the beginning of the next plan year (e.g., January 1, 2021). Recognizing the situation in which these employers find themselves, the IRS issued Notice 2020-52 on June 29, 2020. The new guidance provides specific COVID-19 relief by expanding the circumstances under which safe harbor contributions can be suspended or reduced, with a special amendment deadline of August 31, 2020.
401(k) plans are generally subject to nondiscrimination tests (the ADP and ACP Tests) which limit the contributions made by or on behalf of “Highly Compensated Employees,” compared to those made by or on behalf of “Non-Highly Compensated Employees.” However, if the employer agrees to make “safe harbor” contributions to the plan, the plan is exempt from the nondiscrimination tests. Safe harbor contributions take one of two forms: (a) “nonelective” contributions equal to 3% of compensation and made on behalf of all eligible employees, or (b) “matching” contributions determined under one of several available formulas and made only on behalf of those participants who make employee contributions to the plan.
Under IRS rules, plan provisions for safe harbor contributions are generally required to be in effect prior to the beginning of the plan year and are required to remain in effect throughout the plan year. Historically, safe harbor contributions could only be suspended or reduced mid-year if (a) the employer could demonstrate that it was operating at an “economic loss, ” or (b) the employer had specifically reserved the right to suspend or reduce such contributions in the safe harbor notice provided to employees before the beginning of the year. The term “economic loss” means that the employer’s expenses are exceeding its income, and not merely that it is having a down year. Also, since no employers anticipated the effect that COVID-19 would have when they issued their safe harbor notices to employees prior to 2020, not all employers reserved the right to suspend or reduce their safe harbor contributions. In short, many employers have found themselves to be stuck making contributions they cannot afford.
The New Rules:
Notice 2020-52 now permits an employer to amend its safe harbor plan to suspend or reduce safe harbor contributions during 2020, subject to three conditions: (a) the amendment must be adopted no later than the date the amendment is effective and no later than August 31, 2020; (b) notice of the suspension or reduction must be provided to affected employees no later than 30 days prior to the effective date (for matching contributions) or by August 31, 2020 (for nonelective contributions); and (c) the plan must be subjected to the ADP and ACP (if applicable) nondiscrimination tests for the plan year, given that safe harbor status is being surrendered. Importantly, the relief is available to all safe harbor plan sponsors; an employer need not demonstrate “economic loss” or any other form of business hardship, and need not have included any particular language in its safe harbor notice to employees for 2020.
Notice 2020-52 also confirms a different option under which safe harbor contributions can be suspended or reduced for Highly Compensated Employees only, without losing the safe harbor status of the plan, but subject to notice to the affected employees. Since this confirmation is merely an interpretation of the prior safe harbor rules, it will actually continue to be available beyond 2020.
Contact us if you want to consider adopting an amendment to suspend or reduce safe harbor contributions by the August 31, 2020 deadline.