latest info on eliminating 3% safe harbor mid year

[Tom Poje]

hot off the presses. possible ability to eliminate 3% safe harbor during the year

proposed amendment.

I haven't even looked over it yet it is so hot and out of the oven

[Kevin C]

This sounded like great news, until I read it.

The non-elective safe harbor can only be reduced or suspended mid-year if the employer incurs a substantial business hardship comparable to a substantial business hardship described in Section 412©. Notice, timing and ADP/ACP testing requirements also apply.

Our clients who have been inquiring about suspending safe harbor contributions are looking at options to avoid incurring a substantial business hardship. I don't see anything in the new rules that helps them.

And check out this little jewel from page 11:

In addition, a plan that is amended during the plan year to reduce or suspend safe harbor contributions (whether

nonelective contributions or matching contributions) must prorate the otherwise applicable compensation limit under section 401(a)(17) in accordance with the requirements of §1.401(a)(17)-1(b)(3)(iii)(A).

I don't see any mention of a 411(d)(6) exemption for an amendment to reduce or suspend SH contributions.

[Bird]

What do you think pro-rating the comp limit means? If SHNE is suspended 6 months into the year, you only get 1/2 the comp limit for the full year? I don't quite get it.

[jpod]

Bird: I haven't read it, but I suppose it means that, for example, if your CEO has maxed out at $245,000 x 3% after 4 months, he/she can only get 1/3rd x $245,000 x 3%.

[MSN]

I think the prorated comp limit alpplies to more than just the SH allocation...it would also apply for ADP/ACP testing 415 testing, etc... That's how I'm reading it but would love it if I were wrong.

[K2retire]

The hearing is set for September. If approved it requires a 90 day period to become effective. This won't help anyone for 2009.

[Tom Poje]

I'd say they need to address how the proration is to be applied. note, it says the rule applies to any safe harbor, including matching contributions! never heard that before.

[Bird]

K2retire, the proposed regs are effective immediately.

I agree the pro-rated comp limit appears to apply to everything - testing, other allocations, etc. I guess that is "punishment" for eliminating the SH? That's an...interesting concept.

[Guest Sieve]

The language in the preamble is that you "must prorate the otherwise applicable compensation limit under section 401(a)(17) in accordance with the requirements of §1.401(a)(17)-1(b)(3)(iii)(A)". That would mean, as per the reg cited, that you would prorate when "compensation for a period of less than 12 months is used . . .", not that you would use some prorated comp for all purposes under the plan.

So, it seems to me that, under that preamble statement, in a amendment or suspension situation you'd use prorated comp for the period of time that the SH non-elective contribution is made (see Prop. Treas. Reg. Sections 1.401(k)-3(g)(ii)(G) & 1.401(m)-3(h)(ii)(G)) and also for the period of time when any reduced non-elective contribution is made, and for the period of time each level of match is made (see Prop. Treas. Reg. Sections 1.401(k)-3(g)(i)(E) & 1.401(m)-3(h)(i)(E)), but not for ADP or for Section 415.

Wouldn't that have been the rule under the mid-year amendment rules for the SH match, even before these proposed reg revisions? Why is this a change?

And, I don't think there needs to be a Section 411(d)(6) protection in the regs, as has been suggested, because this change would be a prospective change to the contribution formula with Notice, and because the right to the SH contribution is not accrued for the entire year in a SH plan anymore than the right to a specified contribution is accrued for the entire year in a MPPP when appropriate advanced notice of a prospective change is given.

Just my opinions . . .

(edited for typo)

[Bird]

Thanks Sieve, for explaining the pro-rated comp. That makes sense.

[Belgarath]

"So, it seems to me that, under that preamble statement, in a amendment or suspension situation you'd use prorated comp for the period of time that the SH non-elective contribution is made (see Prop. Treas. Reg. Sections 1.401(k)-3(g)(ii)(G) & 1.401(m)-3(h)(ii)(G)) and also for the period of time when any reduced elective contribution is made, and for the period of time each level of match is made (see Prop. Treas. Reg. Sections 1.401(k)-3(g)(i)(E) & 1.401(m)-3(h)(i)(E)), but not for ADP or for Section 415."

And not for 401(a)(4) either, I presume?

[Belgarath]

I just spoke with Lisa Mojiri-Azad - one of the authors of the regulation, regarding this subject. I'd first like to caveat this by saying I would strongly recommend that you call her with questions in case I have misquoted or misunderstood what she said. Having thus properly forewarned you:

She was extremely pleasant and helpful - but she seemed quite surprised at the number of questions that this issue has generated. The gist was, based upon MY scenario which did NOT freeze the plan or provide for any short plan/limitation year...

As Sieve has suggested, she confirmed that if the plan remains ongoing for all other purposes, and the only change is to reduce or eliminate the safe harbor nonelective, then the comp would be prorated for purposes of the 3% nonelective only. It would not be prorated for 415, 401(a)(4), or ADP purposes.

[Tom Poje]

then if I understand you correctly, if Mr Big made 300,000 in the first 6 months (30 days after amendment), he would only be entitled to 1/2 of 245,000 as far as safe harbor goes (or $3675). but if the company had been kicking in 3% on a payroll basis, then you would have to forfeit the additional amount he had received - though if the plan is top heavy and keys were not excluded, then he would still be ok except his 'extra $' become unsafe harbor money. (unless of course he quits before the last day of the plan year in which case he wouldn't get the top heavy)

(though I really do appreciate the fact someone called her, and hopefully as a result they will clarify the preamble when they release the final regs - since apparently a number of people have called on the issue)

(interesting, 100 downloads on this one so far. you think its a hot topic?)

[Guest Sieve]

That's good to know, Belgarath.

I think the IRS has fueled the fire of misinterpretataion of this premable language in its recent (today) Employee Plans newlsetter (http://www.irs.gov/pub/irs-tege/se0509.pdf), where one of the requirements of the proposed regs listed for reducing or suspending the SH NEC is that "the Section 401(a)(17) compensation limits must be prorated". Boy, that sure straightens things out, doesn't it??

[Kevin C]

The 411(d)(6) issue I see has to do with the SH contribution earned for compensation already received by the date of the suspension. We have a number of plans that allocate the SH contribution either quarterly or each pay period. Even in those plans with annual allocations, participants have earned the right to receive a required contribution under the plan's formula before the suspension becomes effective. Most of our SH plans have at least one participant who earns in excess of the 401(a)(17) limit.

Suppose the top salesman in a basic SH match plan earns $30,000 per month and defers 5% of comp. He terminates at 6/30/09 with $180,000 in comp and a $7,200 SH match. Now, take the same salesman and suspend the SH match at 7/1/2009. He still has compensation of $180,000, but because of the suspension, we can only count $122,500. His safe harbor match for 1/1/09 - 6/30/09 is now $4,900. The amendment reduces his accrued benefit by $2,300. How can an amendment reduce his accrued benefit if there is no 411(d)(6) exemption for the amendment?

The preamble statement says the proration applies for a reduction in the SH contribution, not just a suspension. If the contribution continues at some level for the entire year, how are you using compensation for a period of less than 12 months for a plan year?

[Belgarath]

Tom - yes, I agree.

Kevin - I'm guessing (and I stress the word guessing, because my conversation didn't include a scenario such as you provide)

that the IRS sees it as an issue of "fairness" in that the NHC do not have an opportunity to reach the maximum in a relatively short period, whereas the highly paid folks do (or might). I don't know what would happen on the 411(d)(6) issue - while the IRS might choose not to pursue it, I suspect a participant could perhaps successfully pursue a claim if deprived of an accrued benefit as you suggest.

And your point about a reduction rather than outright suspension is well taken. Again, my conversation did not address a reduction. All of our inquiries from clients have been for an outright suspension, so I didn't really think much about a reduction.

Perhaps once they have digested the initial blitz of questions, the IRS will issue a bit of clarification. 'Twould be nice.

[Guest Sieve]

Kevin --

When you change the SH NEC contribution level by reducing it in mid-year so that it's no longer a SH NEC, you aren't using comp for a period of less than 12 months. You are, however, saying that one level of SH NEC (or match) stops as of X date for compensation earned until that date, and the NEC is at a different level for comp earned after X date. So, you are using a period of less than 12 months for each of the different levels of HEC (or match), and the Section 401(a)(17) regs contemplate that. While there is an exception to 401(a)(17) in the event an employee partcipates for less than a full plan year (Treas. Reg. Section 1.401(a)(17)-1(b)(3)(iii)(B), there is no exception that I can find that covers your hypo--nor, however, can I find a specific exception in the regs under IRC Section 411(d)(6) or ERISA 204(h)/IRC Section 4980F.

In fact, I would argue that, in your hypo, the individual had not accrued the benefit (match) at the time the amendment was made, because the pre-amendment accrual was contingent on other events occurring, such as sufficient time passing under the intial match formula so that the compensation earned is not limited by Section 401(a)(17). Just because the matching contribution may be made on a payroll or other periodic basis doesn't cause that matching contribution to be accured (e.g., on termination of the plan)--likewise if a MPPP contribution were made in advance.

What if you eliminate a MPPP contribution with a 204(h) notice? Doesn't the limitation of 401(a)(17) come into play there? What if the 204(h) notice doesn't eliminate the MPPP contribution, but reduces it going forward? Same issue, isn't it? Isn't it the same, too, when you change a DB formula mid-year?

[austin3515]

Interesting... Let's look at this from a purely cynical perspective... I'm the owner of a business, and I know that I can pay myself at least $245,000 for the whole year. Absent these rules, I decided to give myself a bonus the day before the end of the 30 day notice period to get my comp up to the $245K. I get the whole SHNEC, while my employees get the shaft!

I wonder if they could somehow limit the 401(a)(17) pro ration requirement to those individuals with the power to make that type of decision (i.e., key employees, or even just majority owners).

If so limited, I would agree that the cut-back is justified. But to take away from the Mr. Big, the super-duper sales man employee, is clearly unjustified.

[J Simmons]

Interesting... Let's look at this from a purely cynical perspective... I'm the owner of a business, and I know that I can pay myself at least $245,000 for the whole year. Absent these rules, I decided to give myself a bonus the day before the end of the 30 day notice period to get my comp up to the $245K. I get the whole SHNEC, while my employees get the shaft!

I wonder if they could somehow limit the 401(a)(17) pro ration requirement to those individuals with the power to make that type of decision (i.e., key employees, or even just majority owners).

If so limited, I would agree that the cut-back is justified. But to take away from the Mr. Big, the super-duper sales man employee, is clearly unjustified.

Maybe I've misunderstood the 401(a)(17) pro ration for the mid-year cessation of the 3%-of-pay safe harbor nonelective, but I thought that pro ration would prevent this scenario from playing out.

[Guest Sieve]

But, John, I think Austin objects to that result for a non-owner.

Austin -- Frankly, I don't think we're cutting back on super salesman Mr. Big's accrued benefit. There actually was no accrual until all the facts played out, and the reduction of the measurement period (brought about by the change in the SH NEC) limited comp., resulting in the actual accrual being less than what was deposited in anticipation of the accrual (i.e., the deposit is not the accrual/allocation, but is merely a preliminary deposit towards an eventual allocation). The eventual allocation/accrual to Mr. Big is limited by the pro ration of comp for the appropriate period. And the 401(a)(17) comp limitation applies to everyone so that a proportional share of $245,000 for the year is the upside limit of comp. that can be included for allocation/accrual purposes for any employee.

And, while you're not required to pro rate for the pay period (Treas. Reg. Section 401(a)(17)-1(b)(3)(iii)(B), last sentence), you are--as it turns out, as a result of the mid-year amendment--splitting the plan year into pieces with different match/SHNEC rates, and the total allocation/accrual is the sum of those separate pieces. (Treas. Reg. Section 401(a)(17)-1(b)(3)(iii)(A)). Pro ration is thus required. So, to the extent a SHNEC/match is based on compensation in excess of the pro rated amount for the eventual measurement period (determined as a result of the reduction/elimination of the SHNEC/match), it turns out not to have been accrued when the deposit was made.

What if the plan terminates as of January 30, and Mr. Big had been paid $245,000 in January. Are you suggesting that the required pro ration of compensation--limiting everyone to 1/12 X $245,000 for that one month--would be a prohibited cutback? What if it were a 5% MPPP, $245,000 comp paid in Janaury, & then plan terminated--same question: is it a cutback? I think not.

[austin3515]

What if the plan terminates as of January 30, and Mr. Big had been paid $245,000 in January. Are you suggesting that the required pro ration of compensation--limiting everyone to 1/12 X $245,000 for that one month--would be a prohibited cutback? What if it were a 5% MPPP, $245,000 comp paid in Janaury, & then plan terminated--same question: is it a cutback? I think not.

I hadn't thought of that... But I suppose it is the exact same issue. But for the record, yes, I do think that could be construed as a cut-back. OR, is there some explicit guidance that suggests your right to the full (a)(17) comp limit is not accrued until the end of the year? (I mean other than your analysis aside

[Guest Sieve]

It is interesting to note that Tripodi says that there is no cutback issue in a SH plan when an amendment is made to the match, even though the right to the match is not based on a last-day rule. His support for that position?: the regs, which do not mention any cutback issue. (Tripodi, 2008, Chapter 3B, Section X, Part B.2.g.1, on page 3B.268.) I would say the same thing with regard to the mandatory change in the 401(a)(17) limits following a plan termination or an amendment to the SH match or NEC: the regs don't even hint at a cutback issue.

That being said, Treas. Reg. Section 1.411(d)-3(a)(2) indicates that a change in compensation, if it affects the computation of the accured benefit, might cause there to be a cutback. Likewise, Treas. Reg. Section 54.4980F-1, Q&A-7(a), includes a change in compensation as potentially requiring a 204(h) Notice (which does not apply, of course, to a 401(k)/PSP).

Doesn't probably give you the assurance you want, but that's all I can find on the day before a 3-day weekend!!

[austin3515]

I just want to be perfectly clear about one crucial point:

If you discontinue the safe harbor nonelective, or the SH Match for that matter, there is NO TH exemption no matter what. Therefore, if any of the keys defer/receive 3% of full-year pay or more, then the full 3% THM is due, despite the fact that those contributions were made before they knew they would discontinue.

Put it another way, there is absolutely no relief (in the case of a SHNEC), and probably a severe detriment (in the case of a SHMAC) to discontinuning the SH in a top-heavy plan if the above situation applies.

I assume everyone agrees, but its so shocking I wanted to make sure I wasn't alone...

Once again, small business gets royally screwed by the top-heavy rules, and will be forced to terminate their plans (as the only means of limiting the top-heavy contribution) despite the relief afforded to the mega-corporations of the world...

If I ever get to the senate, this will be my top priority...

[stephen]

austin

I am not willing to make the same blanket statement that "small business gets royally screwed by the top-heavy rules." The impact depends on each plan's circumstances.

The top heavy minimum contribution will not be fully vested (unlike the Safe Harbor Contributions) and therefore may not cost as much as the safe harbor contribution would cost as it is expected some of that contribution would be forfeited before becoming 100% vested. If the plan has Safe Harbor Match, it depends on how much greater the top heavy min is than the Safe Harbor match.

The proposed regulations give ALL businesses with a safe harbor non-elective contribution another option to consider other than plan termination when they can no longer afford to make the contribution.

[jkdoll2]

Dont forget about top-heavy. If the plan runs top heavy - you are still required to make the 3% top heavy contribution on full year compensation. Eliminating the 3% safe harbor doesnt stop that. Thanks

[Kevin C]

Sieve,

The EOB section you cite in your post #22 is in Chapter 3B, Part 2, Section X, Part B, 2.g.1)a) in the on-line version. The argument it references is in the prior paragraph, 2.g.1. That argument is that the match formula can be changed as long as the reduced matching formula applies only to contributions made after the amendment’s effective date. The opposing view is that some advisors take the position that once the requirements to receive the contribution have been satisfied, the participant has accrued a benefit for the entire year's compensation, even the compensation not paid until after the amendment is in effect. Your citation supports the first interpretation. The text also refers you to paragraph 1.e. Paragraph 1.e starts off with: "Compensation taken into account. If a benefit has accrued at the time the amendment is effective, presumably the protected benefit would be based on the compensation earned through the effective date of the new formula, but the IRS has not issued any formal guidance on this issue."

You should look at another section in the EOB. In the on-line version, it is in Chapter 3B, Part 2, Section II, Part D, paragraph 5, Final allocation in plan year in which plan terminates. He says the IRS has not directly addressed the issue of how the compensation dollar limit applies and lists two primary interpretations. He says the more conservative interpretation, to prorate the compensation limit based on the termination date, was expressed in Q&A 16 from the 2001 ASPPA annual conference IRS Q&A session. The more aggressive interpretation is to not prorate the compensation limit unless the plan termination results in a short plan year.

You have an interesting argument for why the amendment triggered 401(a)(17) proration might not cause a 411(d)(6) problem. To me, treating a retroactive effect of the amendment as if it applies to accrued benefits prior to the amendment defeats the purpose of determining if the amendment reduces accrued benefits. I also see guidance that suggests 411(d)(6) protection can apply to amounts accrued under the terms of a plan that exceed statutory limits. One of the requirements in 1.411(d)-4, Q&A 2, (b)(i) for a 411(d)(6) exemption for amendments reflecting statutory changes is that the amendment be timely adopted. If accrued benefits don’t included any amounts that could exceed a statutory limit if other events occur, why is this exemption needed?

I agree with you that the IRS's statement regarding the 401(a)(17) proration issue makes it look like it would apply in circumstances other than just changing or suspending a SH contribution. It appears to me that if it applies when a SH contribution is reduced mid-year, it would apply any time a fixed contribution level is changed mid-year after participants have earned the right to receive the contribution. It also looks to me that their argument would apply to mid-year formula increases as well as decreases. I’m just not convinced that their statement is consistent with their published guidance. If they want 401(a)(17) proration to only apply to suspended or reduced SH contributions, they need to incorporate it into the 401(k)/401(m) regulations. Either way, we need some formal guidance on the issue.

And finally, if the 401(a)(17) proration issue for a formula change is so clear cut, why didn’t the IRS include it in their LRM’s? LRM 6 – Definition of Compensation says “If a determination period consists of fewer than 12 months, the annual compensation limit is an amount equal to the otherwise applicable annual compensation limit multiplied by a fraction, the numerator of which is the number of months in the short determination period, and the denominator of which is 12.” Then, it lists adoption agreement choices to define the Compensation determination period as either 1) the plan year, or 2) a 12 month period ending with or within the plan year. If a document follows the LRM’s, the only time it will provide for 401(a)(17) proration is when there is a short plan year. What are we supposed to do if the IRS says to prorate and the document says the opposite?

[Guest Sieve]

Kevin --

Seems like there is no easy solution to the conservative/aggressive dichotomy in the potential approaches to this topic, at least at this time. As usual, I can support either position, but would take the conservative approach when advising a client.

With your approach, however, I don't know how certain hypos would come out, for example (& I'm not asking for anyone to suggest answers):

• E'ee A earns $250,000 for first 6 months of plan year. Match is maxed at 2% of compensation and plan document determines match on basis of plan year comp. Match is revised upwards, prospectively, to 4% of compensation for the last half of the year. If A already has maxed out his comp, then, using your approach, I assume that the 6% match does NOT apply to him for the rest of the year. If it does apply to him, then how do you figure it? (For someone with only $40,000 earned during the first 6 months, then I assume that the 2% match would apply to those $$, and the 4% match would apply to earnings in the second half of the year.) [Perhaps, in this hypo, you would allocate the match based on compensation which is limited in each 6-month period to the product of the annual limit times a fraction equal to the compensation earned in the specific 6-month period divided by the total compensation earned by the individual during the full year--but I believe there would have to be some limit for each 6-month period.] Does it matter if A defers nothing for the second half of the year and therefore ought not be eligible for the higher match at all?
  
• Same question, but with a mid-year change of the 2% MP allocation to a 4% allocation.
  
• Same MPPP question, but, instead of an upward change in mid-year, the employer gives a timely 204(h) Notice so that no MPP allocation is made post-June 30. (This one may be easier to answere.)
  

The anti-cutback exception you note (Treas. Reg. Section 1.411(d)-4, Q&A-(b)(2)(i)) covers a situation where a full cutback is allowed by IRS pronouncement, in spite fo the regs, following the applicability of new legislation (e.g., eliminating a permissible form of benefit), but a requirement for permitting such a true cutback is that the amendment must be made timely as per statutory or regulatory time-lines. That reg does not stand for the proposition that you may not cutback benefits which exceed current statutory limits.

Also, I don't think that the subsequent use of proportional compensation for a partial year is a retroactive change which cuts back an accrued benefit. Rather, what I'm saying is that any accrued benefit based on compensation is contingent on sufficient time passing that allows the compensation to be permissibly considered under the regs--such as is the case in the event of plan termination resulting in a short plan year.

The LRMs are instructive, perhaps, but I have not seen an IRS-approved document which defines the term "determination period" as it is used in most plans' compensation definition with regard to periods of less than 12 months. I think "determination period" means any period of less than 12 months for which compensation comes into play for benefit accrual purposes. So, I don't think the IRS says one thing and the plan says something different.

In any event, I agree that it would be nice to have some official IRS pronouncement on the subject. Absent that, I guess we'll just have to take our chances.

[Tom Poje]

the topic of pro-rating comp, etc has been submitted as a Q and A for the upcoming ASPPA Western Benefits Conference (end of this month). hopefully the IRS will provide a deeper explanation then.

[Guest Sieve]

Would you be willing to post a summary of any IRS response here?

[Tom Poje]

only if my sources take good notes. They have a ball and chain around my ankles, plus a tracking collar, so there is no way I can attend the conference.