The Small Business Job Protection Act of 1996 added Internal Revenue Code (IRC) Section 401(k)(12) and IRC Section 401(m)(11) to give 401(k) plans alternative design-based safe harbor methods of satisfying the special nondiscrimination requirements for elective deferrals and employer matching contributions, for years beginning after December 31, 1998. Plans that use an alternative safe harbor reduce their administrative costs by avoiding the need to (i) conduct various nondiscrimination tests, and (ii) make corrective distributions to highly compensated employees if the tests are failed.

 

A plan generally meets the safe harbor for elective deferrals if it provides proper notice to participants, and the employer either: (i) under the matching contribution requirement, matches employee elective deferrals up to 3% of compensation dollar-for-dollar, matches contributions between 3% and 5% of compensation at a rate of $1 for every $2 contributed, and does not match contributions of highly compensated employees at a rate greater than the match rate for nonhighly compensated employees; or (ii) under the nonelective contribution requirement, makes a nonelective contribution to a defined contribution plan of at least 3% of an employee's compensation on behalf of each nonhighly compensated employee eligible to participate in the arrangement, without regard to whether the employee makes elective contributions.

 

The I.R.S previously issued guidance on the safe harbor nondiscrimination methods in Notice 98-52. Now the I.R.S. has, in Notice 2000-3, provided additional guidance, discussed below, on satisfying the 401(k) safe harbors.

 

Under Notice 2000-3, a plan may be amended up to thirty days before the last day of the plan year to specify that the 401(k) safe harbor nonelective contribution will be used for the plan year (including that the safe harbor nonelective contribution will be made). Under this option, the notice required to be given to eligible employees before the beginning of the plan year must provide that: (i) the plan may be amended during the plan year to provide that the employer will make a safe harbor nonelective contribution of at least 3% to the plan for the plan year, and (ii) if the plan is so amended, a supplemental notice will be given to eligible employees 30 days before the last day of the plan year informing them of the amendment. If the decision to adopt the safe harbor is made, a supplemental notice to this effect must be provided to all eligible employees no later than 30 days before the last day of the plan year. A plan sponsor that takes advantage of the flexibility provided under the I.R.S. notice is not required to continue using the 401(k) safe harbor nonelective contribution method for the following plan year and is not limited in the number of years that it takes advantage of this flexibility.

 

The safe harbor requirements relating to matching contributions may be met for a plan year either: (i) with respect to the plan year as a whole or (ii) if the plan so provides, separately with respect to each payroll period (or with respect to all payroll periods ending with or within each month or plan-year quarter) taken into account under the arrangement for the plan year.

 

A 401(k) plan may require employees to make cash or deferred or employee contribution elections in whole percentages of compensation or whole dollar amounts and still qualify for the safe harbor.

 

A plan will not fail to satisfy the ACP test safe harbor merely because, after a withdrawal of employee contributions from the plan, the plan suspends additional employee contributions for twelve months or less.

 

A plan that uses the 401(k) safe harbor matching contribution may be amended during the plan year to reduce or eliminate matching contributions, provided: (i) a supplemental notice is given to all eligible employees explaining the consequences of the amendment, and informing them of the effective date of the reduction or elimination of matching contributions and that they have a reasonable opportunity to change their elections; (ii) the reduction or elimination of matching contributions is effective no earlier than the later of thirty days after receiving the notice or the date the amendment is adopted; (iii) eligible employees are given reasonable opportunity to change their cash or deferred elections (iv) the plan is amended to provide that the ADP test, and, if applicable, the ACP test, will be performed and satisfied for the entire plan year using the current year testing method; and (v) all other safe harbor requirements are satisfied through the effective date of the amendment.

 

A plan may satisfy the safe harbor notice requirement if, rather than receiving the required notice on a written paper document, the employee receives the notice through an electronic medium reasonably accessible to the employee subject to certain time and content requirements.

 

Generally, the safe harbor notice must be given to eligible employees within a reasonable period before the start of the plan year. Under Notice 2000-3, however, for plan sponsors adopting a 401(k) safe harbor for the first time for a plan year that begins on or after January 1, 2000 and on or before June 1, 2000, the safe harbor notice satisfies the timing requirement for that plan year if the notice is given on or before May 1, 2000. This transition relief applies whether the 401(k) safe harbor is adopted under a newly established 401(k) plan or under a preexisting 401(k) plan.

 

Generally the safe harbor requirements must be satisfied for the entire plan year. In addition, except for a newly established plan, the plan year must be twelve months long. However, Notice 2000-3 provides that for a cash or deferred arrangement (CODA) added for the first time during a plan year to an existing profit sharing plan, the safe harbor requirements are treated as satisfied for the entire plan year (and the CODA will not be treated as failing this twelve month plan year requirement) provided: (i) the plan is not a successor plan; (ii) the CODA is made effective no later than three months before the end of the plan year; and (iii) the 401(k) safe harbor requirements are otherwise satisfied for the entire period from the effective date of the CODA to the end of the plan year.