McKay Hochman - Commentary

Charts

SAFE HARBOR 401(K) CHART
Bill Grossman, QPA
5/16/03; Rev. 10/30/03; Rev. 12/29/05

These are some of the basics that an employer needs to know before considering a 401(k) Safe Harbor Plan. Each employer's goals, plan design, contribution sources and demographics from a unique scenario which the employer will wish to discuss with his or her plan provider before finalizing the decision to make the plan a 401(k) Safe Harbor Plan.
ADP SAFE HARBOR CONTRIBUTIONS (NO ADP TEST REQUIRED/ACP TEST MAY NOT BE REQUIRED)
3% NONELECTIVE CONTRIBUTION (NEC)
	1.	No Allocation Requirements may be imposed, such as, a 1,000 hour or last-day requirement
	2.	100% Vested
	3.	Not available for in-service withdrawal before age 59½, even for hardship [An exception exists for plans in Hurricane designated areas as provided in the Katrina Emergency Tax Relief Act (KETRA) and Gulf Opportunity Zone Act (GOZA) until December 31, 2006.]
	4.	Can be used to satisfy top-heavy minimum contribution
	5.	Must be used in cross-testing gateway test, may be counted towards satisfying cross-testing.
	6.	Cannot be used to satisfy permitted disparity
	7.	Available in guaranteed or flexible formula:
		a.	Guaranteed provides required 3% each year
		b.	Flexible allows employer to decide each year
OR MATCHING CONTRIBUTION A. OR B. BELOW
A.	BASIC MATCH: 100% of first 3% deferred plus 50% of next 2% deferred
	1.	No Allocation Requirements may be imposed, such as, a 1,000 hour or last-day requirement
	2.	100% Vested
	3.	Not available for in-service withdrawal before age 59½, even for hardship (KETRA and GOZA exceptions apply)
	4.	Can be used to satisfy Top-Heavy minimum contribution
B.	ENHANCED MATCH: Matching formula must be at least as generous as the basic formula
	1.	No Allocation Requirements may be imposed, such as, a 1,000 hour or last-day requirement
	2.	100% Vested
	3.	Not available for in-service withdrawal before age 59½, even for hardship (KETRA and GOZA exceptions apply)
	4.	Can be used to satisfy Top-Heavy minimum contribution
	5.	Rate of match may not increase as deferral percentage increases
NOTE: The top-heavy minimum contribution is waived for plans using either the safe harbor basic or enhanced matching formula, provided there is no allocation of any other employer contributions including reallocation of forfeitures. Such a plan would actually be exempt from the top-heavy rules.
ACP SAFE HARBOR CONTRIBUTIONS (NO ACP TEST REQUIRED)
A.	One of the safe harbor contributions above must be provided.
B.	Once the safe harbor contribution is provided, any non-safe harbor matching formula will satisfy the ACP safe harbor if it meets these requirements:
	1.	Allocation of any discretionary matching contribution cannot exceed 4% of compensation
	2.	Participant elective deferrals in excess of 6% of compensation are not matched
	3.	Rate of match does not increase as deferral percentage increases
	Unlike the Basic or Enhanced Match:
	4.	Non-safe harbor additional match does not need to be 100% vested
	5.	May permit in-service withdrawals
	6.	However, under the final 401(k) and 401(m) regulations, a plan cannot impose a 1,000-hour or last-day allocation requirement on any non-safe harbor match, unless all the non-highly compensated employees meet the allocation requirements.
	7.	If the plan provides for voluntary after-tax deferrals, an ACP test must be run.
SOME IMPLEMENTATION ISSUES
	1.	New Safe Harbor 401(k) Plan Issues:
		a.	A safe harbor 401(k) feature may not be added to an existing profit sharing plan with less than 3 months remaining in the plan year.
		b.	A brand new 401(k) plan must have at least 3 months remaining in the short plan year to immediately start a safe harbor. For example, by October 1 for a calendar year plan.
		c.	An exception to the 3 month rule exists for a completely new business. Such entities may establish a safe harbor plan with as little as one month in the plan year.
	2.	A safe harbor feature may not be added to an existing 401(k) plan during the plan year. The plan may be amended to add the safe harbor as of the first day of the next plan year.
	3.	A notice must be provided to each eligible plan participant each year between 30 and 90 days before the next plan year begins. This is a “safe harbor” period for providing the notice. See the safe harbor notice requirements section below for more information. If the flexible nonelective safe harbor contribution will be made, a second notice must be provided 30 days before the end of the plan year if the plan will actually be providing the flexible contribution.
	4.	A safe harbor match may be discontinued during the year upon 30 days advance notice to employees. The employees must have a chance during the 30-day period to change their deferrals. However, while safe harbor contributions were physically made, ADP and ACP testing will apply for the entire year.
NOTE: Beginning in 2006, the final 401(k) regulations introduce short plan year exceptions that will apply to safe harbor plans for the first time (see below).
TOP-HEAVY PLAN ISSUES
If the safe harbor 401(k) plan is top-heavy, the employer can get twice the mileage out of its safe harbor contribution There are three ways this can happen:
	1.	When a NEC of 3% or more is made to a top-heavy plan, the NEC of 3% or more generally satisfies the top-heavy contribution requirement. Caveat: For a new entrant into the plan who receives the safe harbor contribution for only part of the year, i.e. while a participant, the top-heavy contribution should be for the entire year and thus, such a participant would require an additional top-heavy contribution.
	2.	If the plan is making a safe harbor match and the plan is top-heavy, the match counts towards satisfying the top-heavy minimum contribution for those employees who receive it. For example, if a participant defers 2% and receives a 2% match, when the employer makes the top-heavy contributions, that employee would only have to receive 1% more to satisfy the 3% top-heavy contribution. (The employer may want to consider whether counting matching contributions towards the top-heavy minimum is appropriate; since it penalizes participants actually deferring.)
	3.	A plan that only permits elective deferrals and contributions that satisfy the ADP and ACP safe harbor provisions is exempt from the top-heavy rules. To be exempt, there cannot be any other employer contribution (i.e., profit sharing contribution) and forfeitures cannot be allocated on a basis other than as a match that satisfies the ACP safe harbor. To further clarify, discretionary matching contributions that do not trigger the ACP test (as described above), may also be made.
		a.	elective deferrals, and
		b.	safe harbor contributions (the safe harbor NEC or the safe harbor matching contribution), and
		c.	a match that satisfies the ADP and ACP safe harbor provisions (i.e. a discretionary match that is less than 4% of compensation and that does not match on deferrals above 6%).
Keep in mind that to be exempt, there cannot be any other employer contribution (i.e., profit sharing contribution) and forfeitures cannot be allocated on a basis other than as a match that satisfies the ACP safe harbor. This exemption is determined on an annual basis. Therefore, each year is judged to be exempt or not on its own.
SHORT PLAN YEAR EXCEPTIONS
Exceptions for a New 401(k) Plan That May Utilize the Safe Harbor
	1.	A brand new 401(k) plan may be established at any time during the year provided there are at least three months remaining to the plan year.
	2.	New plans include:
		•	Brand new plans
		•	Existing profit sharing or stock bonus plans that never had a 401(k) feature.
	3.	The exception for a brand new business permits a plan to be established with as little as one month remaining in the plan year.
Exceptions from the Final 401(k) and 401(m) Regulations
	1.	A safe harbor 401(k) plan may have a short plan year in the year the plan terminates provided:
		•	the termination is in connection with a merger or acquisition involving the employer, OR
		•	if the employer incurs a substantial business hardship comparable to that described in section 412(d) (for a minimum funding requirement waiver):
			ο	the employer is operating at an economic loss,
			ο	there is substantial unemployment or underemployment in the trade or business and in the industry concerned,
			ο	the sales and profits of the industry concerned are depressed or declining, and
			ο	it is reasonable to expect that the plan will be continued only if the waiver is granted.
		•	The employer in either of the above situations will remain safe harbored from testing, provided a safe harbor contribution is made for the short plan year.
	2.	A safe harbor 401(k) plan may have a short plan year in the year the plan terminates for reasons other than merger, acquisition or hardship, (however, ADP/ACP testing will be required) provided:
		•	the employer makes the safe harbor contributions for the short period,
		•	the employees are provided with a notice of the change, and
		•	the plan must pass the actual deferral percentage (ADP) test and actual percentage test (ACP). (Since testing is required it really isn’t like a safe harbor plan anymore.)
NOTE: Whether or not the plan passes the ADP/ACP test, the employer must make safe harbor contributions through the plan termination date. For the record, if the plan provided a safe harbor matching contribution, it would follow the current procedure to suspend the safe harbor matching contributions. This requires a 30-day advance notice to participants, providing the participants with reasonable opportunity to stop deferring, and performing ADP/ACP testing of the short plan year.
	3.	A safe harbor 401(k) plan may run a short plan year to change from a fiscal plan year to a calendar plan year or vice versa, provided the plan is a 12-month safe harbor plan in both the preceding and following plan years.
Example: A safe harbor 401(k) plan has a plan year of July 1 to June 30. The employer wants to switch to a calendar plan year. The plan provides the 3% safe harbor nonelective contribution for the July 1, 2005, to June 30, 2006, year. The plan is then amended to run a short plan year from July 1, 2006, to December 31, 2006 during which the safe harbor contribution is made. Then, the plan provides the safe harbor 3% qualified nonelective contribution from January 1, 2007, to December 31, 2007. This would satisfy the requirement in the regulation for changing plan years as a safe harbor 401(k) plan, and no testing would be necessary.
SAFE HARBOR NOTICE REQUIREMENTS OF THE FINAL 401(K) AND 401(M) REGULATIONS
Timing requirement
	•	General rules: Provide the notice within a reasonable time before the beginning of the plan year.
	•	The notice is deemed to satisfy the timing requirement if it is provided to each eligible employee not less than 30 days but not more than 90 days before the beginning of each plan year.
	•	Newly eligible participant (defined as becoming eligible after the 90th day before the beginning of the plan year)
		ο	Deemed to satisfy the timing requirement if provided by:
			•	not more than 90 days before the employee becomes eligible, but
			•	not later than the date the employee becomes eligible.
	•	A new plan provides timely notice if it follows the same rule as described above for a newly eligible employee. Thus, a new plan can provide the notice as late as the effective date of the plan.
Content requirement
	•	The notice must be written to be understood by the average employee who is eligible to participate in the plan;
	•	It is sufficiently accurate and comprehensive to inform the employee of the employee’s rights and obligations under the plan; and must describe:
		ο	The safe harbor matching or safe harbor NEC used in the plan, including levels of matching;
		ο	Any other contributions under the plan or matching contributions to another plan based upon deferrals to this plan and the conditions under which such contributions are made;
		ο	The plan to which the safe harbor contribution will be made, if other than the plan with the CODA;
		ο	The type and amount of compensation that may be deferred under the plan;
		ο	How to make deferral elections, including any administrative requirements;
		ο	The periods under the plan for making deferral arrangements;
		ο	Withdrawal and vesting provisions applicable to contributions under the plan; and
		ο	How to obtain additional information about the plan, including an additional SPD, by providing telephone numbers, addresses and if applicable electronic addresses of individuals and/or offices that can provide such information to employees.
	•	References to SPD. The notice may make cross-reference to the SPD for:
		ο	Any other contributions in the plan;
		ο	The plan that the safe harbor contribution will be made; or
		ο	Relating to the type or amount of compensation that may be deferred under the plan.
NOTE: In Notice 2005-95, the IRS stated that for plan years that begin before 2007, a safe harbor 401(k) plan will not fail to satisfy the safe harbor notice requirement of the final 401(k) regulations if the notice cross-referenced the plan’s summary plan description (in accordance with the prior guidance in Notice 2000-3 Q&A-8 regarding the vesting and distribution provisions for contributions).
Each employer's goals, plan design, contribution sources and demographics form a unique scenario that the employer will wish to discuss with his or her plan provider before finalizing the decision to make the plan a 401(k) safe harbor plan.


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