Notice 2016-16 provides a vehicle under which mid-year changes can be made to a safe-harbor §401(k) plan that will not be held to violate the safe harbor rules.
A major complicating factor when attempting to operate a §401(k) retirement plan in small and mid-sized businesses arising from the need to meet tests meant to insure that the benefits aren’t utilized to a significantly larger extent by the highly compensated employees (HCEs) as compared to non-highly compensated employees. Elective contributions made by highly compensated employees are subjected the actual deferral percentage limitations (ADP testing) while an actual contribution percentage test (ACP testing) is applied to matching contributions and employee contributions.
With a smaller population, the decisions of a few of the non-highly compensated employees to reduce contributions or opt to make no contributions may severely impact the potential benefits of the highly compensated employees. Congress enacted the “safe harbor” provisions to deal with this potential problem.
In exchange for agreeing to certain requirements (including minimum vested contributions or specified matching criteria), the plan will be exempted from the ADP/ACP testing provisions, thus allowing the HCEs to make the maximum allowed deferrals without risk of discovering after the fact that they have made an excess contribution that will now be removed from the plan.
Generally the provisions required must be in force for an entire 12 month period in order to meet safe harbor status. However certain exceptions are carved out by the safe harbor plan regulations. As the notice indicates:
These include exceptions for (i) a short first plan year, (ii) a change in the plan year, (iii) a short final plan year, (iv) a delayed adoption of safe harbor plan nonelective contributions (if notice of this possibility is provided before the beginning of the plan year), and (v) a mid-year reduction or suspension of safe harbor contributions (which results in loss of safe harbor plan status). See §§ 1.401(k)-3(e), (f), and (g) and 1.401(m)-3(f), (g), and (h). In addition, exceptions to the prohibition against mid-year amendments may be provided in guidance of general applicability published in the Internal Revenue Bulletin. See §§ 1.401(k)-3(e) and 1.401(m)-3(f).
In addition to provisions required in the plan, a safe harbor plan must also issue certain specified notices to employees. As the notice provides:
To meet the content requirements, a safe harbor notice must be sufficiently accurate and comprehensive to inform an employee of the employee's rights and obligations under the plan, and written in a manner calculated to be understood by the average employee eligible to participate in the plan. Under the safe harbor plan regulations, a notice is not considered sufficiently accurate and comprehensive unless the notice accurately describes certain information specified in those regulations, including the plan's safe harbor contributions, any other plan contributions, the type and amount of compensation that may be deferred under the plan, how to make cash or deferred elections (including any administrative requirements that apply to the elections), the plan's withdrawal and vesting provisions, and specified contact information. See §§1.401(k)-3(d) and 1.401(m)-3(e). In addition to satisfying the general content requirements for a safe harbor notice, a safe harbor notice for a QACA (qualifying automatic contribution arrangement) must describe certain additional items, including the level of elective contributions that will be made on the employee's behalf if the employee does not make an affirmative election and how contributions will be invested. See §1.401(k)-3(k).
The notices must also meet certain timing requirements, generally provided at least 30 days but no more than 90 days, before the beginning of the plan year for which safe harbor treatment is desired.
Under the notice, a mid-year change does not violate the requirements for a safe harbor plan if it is a mid-year change to a plan’s required safe harbor notice content, the notice and election opportunities described below are met and it’s not a change listed as a prohibited change in the notice.
However this notice doesn’t govern the following changes, for which a plan will need to meet the regulatory conditions for an acceptable change:
- Adoption of a short plan year or any change to the plan year (permitted only as described in §§ 1.401(k)-3(e)(2), (3), and (4) and 1.401(m)-3(f)(2), (3), and (4));
- Adoption of safe harbor plan status on or after the beginning of the plan year (permitted only as described in § § 1.401(k)-3(f) and 1.401(m)-3(g)); and
- Reduction or suspension of safe harbor contributions or changes from safe harbor plan status to non-safe harbor plan status (permitted only as described in § § 1.401(k)-3(g) and 1.401(m)-3(h)).
The required notice requirements for a change covered by this notice are:
- An updated safe harbor notice that describes the mid-year change and its effective date must be provided to each employee otherwise required to be provided a safe harbor notice under §1.401(k)-3(d), 1.401(k)-3(k)(4), or 1.401(m)-3(e), as applicable, within a reasonable period before the effective date of the change. Whether this timing requirement is met is based on all of the relevant facts and circumstances, but this timing requirement is deemed to be satisfied if the updated safe harbor notice is provided at least 30 days (and not more than 90 days) before the effective date of the change. If it is not practicable for the updated safe harbor notice to be provided before the effective date of the change (for example, in the case of a mid-year change to increase matching contributions retroactively for the entire plan year), the notice is treated as provided timely if it is provided as soon as practicable, but not later than 30 days after the date the change is adopted. For purposes of this notice rule, if the required information about the mid-year change and its effective date was provided with the pre-plan year annual safe harbor notice, an updated safe harbor notice is not required.
- Each employee required to be provided an updated safe harbor notice must be given a reasonable opportunity (including a reasonable period after receipt of the updated notice) before the effective date of the mid-year change to change the employee's cash or deferred election (and/or any after-tax employee contribution election). For this purpose, a 30-day election period is deemed to be a reasonable period to make or change a cash or deferred election. If it is not practicable for the election opportunity to be provided before the effective date of the change (for example, in the case of a mid-year change to increase matching contributions retroactively for the entire plan year), an employee is treated as having a reasonable opportunity to make or change an election if the election opportunity begins as soon as practicable after the date the updated notice is provided to the employee, but not later than 30 days after the date the change is adopted.
Prohibited changes are listed in Section III.D. of the notice:
- A mid-year change to increase the number of completed years of service required for an employee to have a nonforfeitable right to the employee's account balance attributable to safe harbor contributions under a QACA pursuant to the safe harbor rules under § 1.401(k)-3(k)(3) or 1.401(m)-3(a)(2).
- A mid-year change to reduce the number or otherwise narrow the group of employees eligible to receive safe harbor contributions. This prohibition does not apply to an otherwise permissible change under eligibility service crediting rules or entry date rules made with respect to employees who are not already eligible (as of the date the change is either made effective or is adopted) to receive safe harbor contributions under the plan.
- A mid-year change to the type of safe harbor plan, for example, a change from a traditional § 401(k) safe harbor plan to a QACA § 401(k) safe harbor plan.
- A mid-year change (i) to modify (or add) a formula used to determine matching contributions (or the definition of compensation used to determine matching contributions) if the change increases the amount of matching contributions, or (ii) to permit discretionary matching contributions. However, this prohibition does not apply if, at least 3 months prior to the end of the plan year, the change is adopted and the updated safe harbor notice and election opportunity are provided, and if the change is made retroactively effective for the entire plan year (which may require a plan that provides for periodic matching contributions as described in §§1.401(k)-3(c)(4) and (5)(ii) and/or 1.401(m)-3(d)(4) to be amended to provide for matching contributions based on the entire plan year).