Make the Change

IRS Expands Midyear Safe Harbor Plan Changes

Effective January 29, 2016, the IRS announced a policy change which now allows sponsors of safe harbor 401(k) plans more flexibility to make “midyear” changes to their plans. The changes are outlined in IRS Notice 2016-16.

ERISA 1.401(k)-3(k)(3) or 1.401(m)-3(a)(2)

Safe Harbor Basics

Safe harbor plans enable plan sponsors to automatically satisfy the annual actual deferral percentage and actual contribution percentage (“ADP/ACP”) discrimination tests. This can be beneficial to plans with a low level of participation by non-highly compensated employees. Without a safe harbor provision in the plan — and the plan fails the ADP/ACP tests — some of the salary deferrals that highly compensated employees set aside in their 401(k) accounts is returned to them as taxable income so the plan can pass the ADP/ACP tests.

There are two requirement to the safe harbor regulations: (1) a minimum matching contribution formula (100% of the first 3% of pay and 50% of the next 2%, or alternatively a 100% match on at least 4% of pay), or (2) a nonelective employer contribution (at least 3% of the employer contribution to all eligible participants regardless of whether they defer). Now, according to the IRS, subject to certain limitations, the safe harbor regulations offer some flexibility with respect to other plan design options.

Midyear Updates

“Midyear” doesn’t necessarily mean specifically six months into the plan year. Rather, midyear changes are those that are effective:

  • During a plan year, but not effective as of the beginning of the plan year, or
  • As of the beginning of the plan year, but adopted after the beginning of the plan year.

There are numerous midyear changes already addressed in the regulations that have their own regulatory requirements and restrictions. Notice 2016-16 doesn’t apply to these changes and they remain subject to their specific regulatory requirements:

  • Midyear adoption of a new safe harbor plan,
  • Adoption of a short plan year or a midyear change in the plan year,
  • Midyear reduction or suspension of safe harbor contributions,
  • Midyear plan termination, or
  • Use of the “maybe” notice to change to safe harbor status.

Impermissible Changes

Even though the IRS has relaxed the rules for some midyear safe harbor plan changes, it doesn’t apply to all changes. Plan sponsors cannot make midyear changes to:

  1. Increase the number of completed years of service required for an employee to have a nonforfeitable right to the employee’s account balance attributable to safe harbor contributions under a qualified automatic contribution arrangement (“QACA”), pursuant to the safe harbor regulations,
  2. Reduce or narrow the number of employees eligible to receive safe harbor contributions,
  3. Change the type of safe harbor plan — for example, from a traditional 401(k) safe harbor plan to a QACA 401(k) safe harbor plan, or
  4. Change or add a formula used to determine matching contributions (or the definition of compensation used to determine matching contributions) if the change increases the amount of matching contributions, or allows discretionary matching contributions.

The restriction in item (2) above doesn’t apply to an otherwise permissible change under eligibility service crediting rules, or entry date rules made with respect to employees who aren’t already eligible (as of the date the change is either made effective or is adopted) to receive safe harbor contributions under the plan. Please refer to Notice 2016-16 for more technical explanations of impermissible changes and exceptions to these areas.

Required Notice and Examples

Notice 2016-16 sets out two participant notification requirements, if the plan sponsor intends to make a midyear change to a safe harbor plan. First, within a reasonable time, the plan sponsor must provide a notice describing the change of the contribution and its effective date to each employee. A reasonable (time would be at least 30 days and not more than 90 days). Second, employees who receive the notice must be given a reasonable opportunity to change their cash or deferred election.

Notice 2016-16 features several examples illustrating when certain midyear plan amendments are and are not permissible. An employer sponsoring a traditional 401(k) safe harbor plan doesn’t violate the rules when it makes a midyear plan amendment to increase future safe harbor nonelective contributions from 3% to 4% for all eligible employees. In this situation, the employer must provide the following to all employees:

  1. An updated notice describing the increased contribution percentage, and
  2. Must give employees a reasonable opportunity to make or change their election before the effective date of the midyear change.

In the second example, instead of increasing the nonelective contribution, the sponsor was planning to do the opposite, lower it from 4% to 3%. That would not be allowed, even though a 3% nonelective contribution rate would be permitted, if the amendment was made effective as of the beginning of the plan year.

Learn More

Notice 2016-16 contains technical caveats and limitations too numerous to describe in this article. However, sponsors of safe harbor plans, guided by ERISA experts, might find it worthwhile to exploit the new flexibility it allows.

© 2016

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