Safe Harbor Plan - Change In Plan Year

[austin3515]

From the EOB:

The regulations issued on December 29, 2004, provide that, if a short plan year is created by plan amendment, the ADP and ACP safe harbors is available if both of the following conditions are satisfied: (1) the plan year immediately preceding the short plan year satisfied the 401(k) safe harbor rules (i.e., the plan already must be a safe harbor plan when the plan year is changed to create a short plan year), and, (2) the plan year immediately following the short plan year also satisfies the 401(k) safe harbor rules. See Treas. Reg. §§1.401(k)-3(e)(3) and 1.401(m)-3(f)(3). If the plan year immediately following the short plan year is also a short plan year, then the safe harbor requirements must be satisfied for at least the 12-month period following the end of the short plan year (unless the exception for plan terminations, as described in 2.c. below, applies).

According to the EOB, the conservative approach is to amend the plan year BEFORE the short plan year begins. So your short plan year be from 1/1/2011 through 9/30/2011. But that is based on one Treasury officials remarks at an ASPPA conference, and Sal definitely felt there was room for interpretation. Especially considering the only two requirements set forth in the regulations COULD still be satisfied if you made 1/1/2010 to 9/30/2010 your short plan year.

[John Feldt ERPA CPC QPA]

A safe harbor 401(k) plan has a December 31 Plan Year end. A change is desired to have the plan year end to match the fiscal year end (September 30). They intend to keep the plan as a safe harbor 401(k) for future plan years.

Can they:

A) adopt an amendment now to make this plan year a short year, ending on September 30, 2010? or

B) the earliest plan year end they can change is the next plan year, starting 1-1-2011, must be amended before 1-1-2011?

[John Feldt ERPA CPC QPA]

Thanks, I think the argument Sal poses is sound. TAG would only cite official guidance.

Excerpts from the 2009 ERISA Outline Book (EOB), Chapter 11, Part I, 2.b.2):

Timing of the amendment to change the plan year. At the 2005 ASPPA Annual Conference, a representative from the Treasury indicated that the amendment in the prior example would have to occur before the short plan year begins (i.e., by July 1, 2006, in that example, if the short year is to end December 31, 2006).

Why? The argument raised was that, as of July 1, 2006, employees have an expectation that their matching contribution for the plan year (i.e., July 1, 2006, through June 30, 2007) would be matched on the basis of the entire year’s compensation.

Consider the following example. Suppose an employee’s compensation for the period July 1, 2006, through June 30, 2007, is $60,000, with $30,000 earned in the first six months and $30,000 in the second six months. Further assume the employee defers at a rate of 10% and the plan uses the basic matching formula under IRC §401(k)(12)(B). If the short year is created as of January 1, 2007, then the matching contribution formula would yield a match of 5% of compensation under the basic formula, for a match of 5% x $30,000, or $1,500. Had the plan year gone the full 12 months, the match would have been 5% x $60,000, or $3,000.

The Treasury official was suggesting that this could be a violation of the safe harbor rules because the safe harbor notice given for the plan year beginning July 1, 2006, would have suggested that the match for that year would be based on compensation for a 12-month period ending June 30, 2007. This argument fails to consider that this type of amendment is allowed only if the plan remains a safe harbor 401(k) plan for the 12-month period following the close of the short plan year. Thus, the safe harbor formula will apply for the 6-month period running through June 30, 2007, it’s just that the 6-month period is now part of the first half of the calendar plan year starting January 1, 2007, rather than the second half of the plan year that started on July 1, 2006.

It also could be argued, if the plan’s matching formula is determined on a payroll period basis, rather than a plan year basis, that the change in the plan year period is irrelevant anyway to the expectation of safe harbor contributions. If the IRS actually would raise an issue here (remember, the comments of the official at the ASPPA conference do not necessarily represent the official position of the agency), it seems to create an unfortunate trap for the unwary. It is the exception to the rule that a change in a plan year would be planned ahead in sufficient time to adopt an amendment to the plan year (or at least provide a safe harbor notice that would alert employees to the pending change) before the beginning of what will become the short plan year. To take a position like this would render meaningless the option to amend a safe harbor 401(k) plan to a different plan year period.