Proposed IRS rules would allow employers that made automatic 401(k) plan contributions under a safe-harbor provision to suspend or reduce those contributions if they incurred a substantial business hardship.
The proposal, which the Internal Revenue Service said is intended to decrease the likelihood that financially distressed employers will terminate 401(k) plans, applies to companies that qualify for a safe harbor by making an automatic contribution to employees' 401(k) accounts equal to 3% of employees' pay.
By qualifying for the safe harbor, employers do not have to run an IRS non-discrimination test to determine that average salary deferrals of higher-paid employees do not exceed those of rank-and-file employees by a legally set amount.
The advantage of not having to pass the non-discrimination test is that higher-paid employees can contribute up to $16,500 a year for those 49 and younger and $22,000 for those 50 and older, without regard to how much lower-paid employees put in.
AVOIDING A MESS
That avoids problems such as employers having to return contributions to higher-paid employees, which can be administratively messy, said Robyn Credico, national director of defined contribution plan consulting for Watson Wyatt Worldwide Inc. in Arlington, Va.
In addition, employers can “communicate with confidence” to employees regarding how much they can contribute, said Michael Weddell, a Detroit-based principal with Mercer LLC of New York.
The IRS proposal is an extension of a rule, finalized in 2004, that allows employers qualifying for another safe harbor, one where they have to match 100% of employees' deferrals on the first 3% of pay and match 50% of deferrals made on the next 2% of pay.
The earlier rules on match-based 401(k) safe-harbor plans, though, do not require employers to prove a substantial business hardship to suspend or reduce contributions.
Like the earlier rules, the proposal sets other requirements employers would have to meet, including notifying employees. In addition, an employer's 401(k) plan would have to pass the non-discrimination test for the entire year in which it suspended or reduced contributions.
Absent the IRS proposal, the only option for employers no longer able to afford automatic contributions would be terminating their plans. That is because of IRS rules that say employers must comply with safe-harbor requirements, including continuing contributions, for an entire plan year.
WELCOMED PROPOSAL
Benefit experts welcomed the proposal as one that aids employers and employees. By knowing they are not locked into their contributions when the economy slumps, a “barrier is removed” that might have discouraged some employers from moving to an automatic-contribution 401(k) plan that qualifies as a safe harbor from non-discrimination testing, said Bill McClain, a Mercer principal in Seattle.
Additionally, if financially distressed employers continue their plans, employees can still contribute to their retirement. Employers that later resume automatic contributions of 3% then would again be exempt from non-discrimination testing.
“There is no downside here,” said Cindy Milsted, an attorney with Hewitt Associates Inc. in Lincoln-shire, Ill. If adopted, the rules will apply to plans amended after May 18, the date the proposal was published in the Federal Register.
Jerry Geisel is a reporter for sister publication Business Insurance.
