In the Wake of COVID-19, Can We Make a Mid-Year Adjustment to Our 401(k) Plan?

By: Stewart M. McGough

One of our prior newsletter items addressed employers’ concerns with continuing obligations under their pension and 401(k) plans. It focused on employers’ continuing obligations to fund their defined benefit pension plans and how they could “freeze” those plans to reduce their future contribution obligations.

This newsletter will focus on 401(k) plans and, in particular, the “safe harbor” contribution feature often adopted by employers.

In a 401(k) plan, the employees have the right to defer a portion of their wages and salary by contributing “salary deferrals” to the Plan, and the employer may add its own “profit sharing” feature as well. The employees’ salary deferrals are subject to a special non-discrimination test that in practice often requires the Plan to return to the higher-paid participants some of their deferrals.

Congress encouraged the adoption of 401(k) plans by allowing employers to use one of two safe harbor (“SH“) options to avoid the special non-discrimination test. One safe harbor is a flat 3%-of-pay employer contribution for all Plan participants regardless whether the participant contributed salary deferrals. The other is a matching feature that obligates the employer to contribute as much as 4% of pay, but only for those employees who make salary deferral contributions.

Mid-Year Changes.

IRS considered SH features very generous and put stringent rules on their use, effectively preventing an employer from making any “mid-year” change to the SH once an employer adopted it. This held true whether changing from one SH to another, or if terminating the SH feature during the year.

These rules have been modified by recent legislation under the SECURE Act of 2019 and the CARES Act of 2020. Beginning 2020, an employer who put in a 3% SH feature can suspend or terminate the safe harbor at any time during the year after giving 30 days advance notice to its employees. But, unless the employer reinstates the 3% SH before the end of the year, the employer loses the “pass” it had on the special testing for deferrals. That will normally mean that either the employer will have to refund some of the salary deferrals made by its highly-paid employees, or make a special one-time contribution that is shared among its non-highly paid employees.

If the employer changes its mind later in the year (or even during the following year), it can reinstate the 3% SH effective retroactive to the beginning of the year, provided reinstatement occurs by December 1 (for a calendar year plan). If the reinstatement occurs after December 1 (and even as late as December 31 of the following year), the retroactive reinstatement is still effective, but the contribution increases from 3% to 4%.

This ability to suspend the safe harbor contribution mid-year and reinstate later in the year only applies to the 3% SH, not to the 4% match SH. If at any time during the year the Plan included the 4% match, no mid-year change can be made that gives the employer the opportunity to reinstate. In other words, suspending the 4% SH match will mean loss of the “pass” on the special non-discrimination test for that year and each ensuing year until a SH feature is again adopted.

With COVID-19’s enormous disruption to the nation’s workforce, this new ability to modify the safe harbor obligation mid-year should prove to be helpful to those employers with safe harbor.

New Adoption of the SH Feature.

An employer whose 401(k) plan does not already have a 3% SH feature may adopt that feature as late as 30 days prior to the end of the Plan Year (December 1 for a calendar year plan). The prior rule required adoption 90 days prior to the end of the year. The 90-day rule still applies if the employer is adopting the 4% match safe harbor.

Modified Notice Requirements

One of the more annoying conditions to a valid safe harbor feature is the requirement that participants receive, prior to the beginning of each year, notice of the SH feature in the Plan. Participants had to be notified of either feature at least 30 days before the beginning of the Plan Year (or when the SH was being first adopted mid-year). Certainly, advance notice of a matching contribution feature is warranted, since we can only expect that a participant’s deferral election will be affected by the existence of the match. Why advanced notice was important in the case of a 3% fixed SH contribution still escapes this author. Someone in Congress saw the irrelevance of this, and now the notice requirement in the case of the 3% SH has been eliminated.

We trust these new rules will help employers to navigate the stressful times we are experiencing today. Should you have any questions, call any of us in the Pension Department:

Stewart M. McGough, Esq.: (315) 477-6225 or [email protected]
Catherine A. Ray, Esq.: (315) 477-6250 or [email protected]
Jean A. Borrow, Paralegal: (315) 477-6258 or [email protected]