Ceasing SH NEC

[Guest Sieve]

Employer is having severe financial difficulties and, 2 months into the plan year, wants to eliminate non-elective safe harbor contribution without terminating the plan. For some reason, the regs do not permit elimination of the SH NEC unless the plan terminates--although the regs do permit elimination of the match SH: in both circumstances, SH contributions must be made until the plan amendment eliminating those contributions and the plan must pass ADP/ACP for the entire year. Any idea why the regs don't permit elimination of the NEC with the same limitations? If you can eliminate a money purchase contribution on a prospective basis, why not a SH NEC?

[DMcGovern]

The regs do provide for the "maybe" version of the 3% NE contribution. I guess that was their way of giving Employers an "out" each year.

I agree with you that something should be done, particularly during these difficult financial times, to give employers viable options in order to keep their plans in place.

[ERISAnut]

This is new to me; as I haven't seen the reg. It doesn't seem to make sense. What I typically do is refer the language inside the BPD (IRS approved, of course) to determine whether or not the plan is actually written consistent to my interpretation of the Reg. In looking at a BPD, I cannot verify it. Of course, we know when the plan's language contradicts the Regs, you must follow the Regs. Arguably, the IRS's opinion letter would imply they read the provision and shares the same opinions on how the Regs are interpreted.

Hope this helps.

[JRN]

It seems to me that the Employer should be able to terminate the 3% safe harbor contribution at anytime during the plan year, with the following caveats: (1) Termination must be prospective only, e.g., if employer deletes safe harbor provision from Plan effective February 28, 2009, the Employer must still fund the 3% contibution for compensation paid through February 28, 2009; (2) The Plan must be tested for ADP compliance for entire plan year.

This just seems correct to me. I know there is not express authority under regs. providing for this treatment. But, is there any IRS authority saying that this treatment is NOT allowed?

Thanks.

[Belgarath]

JRN - it is really the other way around. To paraphrase, the regs say that you must fund the safe harbor contributions. That's your express authority requiring the SH, UNLESS there is a special dispensation to not make them. And there is such a special dispensation for plan terminations, and for SH matching. Since there is NOT such a dispensation for the SH nonelective, you are stuck with making it.

I think nearly everyone agrees that this makes no sense, but that's what we are stuck with.

[Guest Sieve]

I would agree with Belgarath. The cites are Treas. Reg. Sections 1.401(k)-3(e)(4) and -3(g).

[BG5150]

Does a SH notice say the contribution is for the year or the plan year? Could you amend to have the plan year shifted to say 3/1 to 2/28, and eliminte the SH for the new plan year, and just have to make the SH for the short plan year (1/1 to 2/28)?

Then, maybe, in December, amend back to calendar year?

[Guest Sieve]

I don't think a change of plan year can be made without IRS approval if a prior plan year change has been made within the past 5 years. Also, a SH plan which changes to a short plan year must reamain SH for at least 12 months after the end of the short plan year (Treas. Reg. Section 1.401(k)-3(e)(3)).

[JRN]

Belgrath, Sieve -- Thanks for your comments. I expect this issue to come up repeatedly this year as employers deal with the economic downturn. I would hate to have to advise client(s) facing this situation that they have to terminate the whole plan. I'd much rather advise them to (1) fund the SH 3% through the date of plan amendment, (2) allow those participants who want to make new elections to make new elections, (3) keep the 401(k) feature in place so participants can continue to save, and (4) consider moving to a match or discretionary contribution for the balance of the year. This is, in my view, a much better result. And, where is the harm or potential for tax abuse -- I just don't see it.

[Guest Sieve]

JRN - I think we all would agree with you that your approach is preferable. And, I don't see an abuse as long as the plan passes ADP for the full year despite the elimination of the NEC, and as long as the NEC is contributed for compensation through the date of the NEC's elimination--sort of like a 204(h) situation used for a money purchase pension plan. But, the 401(k) regs do not permit it, and the 204(h) regs do not apply.

I think the abuse that is seen is the ability to wait until later in the year, determining that ADP will be passed, and then terminating the promised NEC on that basis. Also, the IRS may see the promised employer SH NEC (as opposed to a discretionary NEC) as a type of mandatory contribution, sort of like a MPPP contribution, and thus no elimination is permitted because the 204(h) regs do not apply to 401(k) SH NECs. The regs allow for a "maybe" SH NEC, where nothing is promised until year-end, and the IRS apparently believes that that's the preferable choice for the employer it it wants to consider not making the SHNEC: i.e., don't promise it until you're sure you want to make it for the whole year.

In these economic times, that's what all SH NEC's should be drafted as: "maybe". (Note that the IRS does not allow correction of a failed SH (i.e., not giving the SH notice) by simply passing ADP for the year--the NEC must be given, if that's what was promised, as part of an EPCRS correction.)

I would not recommend your approach to a client without a clear CYA letter that such an approach is not formally permitted or authoirzed.

This situation should be (if it hasn't already) a question to the IRS at an upcoming ASPPA Q&A session.

[Guest Ohio City]

Sieve -

Do you know if anyone has raised the question regarding the suspension of the safe harbor NEC with the IRS at either the Atlanta ASPPA conference or the one currently being held in LA?

[Guest Sieve]

Sorry, but I don't know. I'm not (yet) an ASPPA member nor do I go to their conferences. But we have lots of ASPPA members on this Board, and perhaps one of them knows.

With the economy in the dumpster, I would suspect that the IRS will be answering that question at some conference somewhere soon--and, hopefully, we'll find out about it on this Board.

[Tom Poje]

while I did not attend, a good source indicated the following from Los Angeles conference, regarding stopping a safe harbor rather than terminating the plan:

This came up again at LABC yesterday, and the IRS has not changed their position even with the heavy lobbying of Craig Hoffman. So, you are correct in your assessment – it doesn’t make sense, but the rules are the rules.

[Guest Sieve]

No, I think it makes great sense, Tom . . . Can't cease SH NEC contribution in mid-year, so just terminate the plan in mid-year to stop the SH NEC and then participants no longer have the ability to defer into a 401(k) (and may also lose their ability to contribute on a deductible basis to an IRA.) Ah, yes, that really makes sense--another example of good retirement planning policy. . . (sort of like that great, but short-lived notion a few decades ago to assess an excise tax to plan distributions above $150,000--now there was an idea worthy of a plaque in the tax legislation hall of fame!!).

[Tom Poje]

Sieve: the comments (making sense or not) were not mine, I was just posting the message.

[Guest Sieve]

I wasn't really directing my tongue-in-cheek (facetious?) comments your way, Tom. I was just mumbling to myself, out loud . . . I guess you overheard.

You'd think after all these years in the business that I wouldn't be surprised by regulations which do not make for good policy, but I am. Maybe that means I'm still hopeful -- or perhaps naive (probably the latter).

Here's how I see the SH NEC amendment issue . . . (1) In the "maybe" approach, the employees either get a full 3% (no ADP test) or nothing at all (pass ADP). (2) In the plan termination approach--where the plan terminates in mid-year since you can't amend the SH NEC mid-year--participants receive a partial SH NEC, but deferral capability is eliminated entirely (and plan must pass ADP). (3) If SH NEC mid-year elimination (by amendment) were permitted, the result would be the same as in (2)--i.e., partial-year NEC, must pass ADP--with the extra added attraction that deferral capability will not have been eliminated. Sounds like a win-win to me (and a whole lot better for participants than the result in the "maybe" scenario).

But, then, we've already said that it makes no sense . . . haven't we??

[K2retire]

In the small plan world it is less of an issue. Even if they could amend out of SHNEC mid year, most would still owe a 3% top heavy minimum.

[WDIK]

This came up again at LABC yesterday, and the IRS has not changed their position even with the heavy lobbying of Craig Hoffman. So, you are correct in your assessment – it doesn’t make sense, but the rules are the rules.

I can also confirm such a discussion.