Jason W. Douthit, Esq.

Barry Berkman is bored and morally conflicted with his life as a contract killer.  Barry’s long-time boss and connection to the underworld, Monroe Fuches, loves the work but senses that he is getting too old for such a violent career.  After talking with a career counselor, Barry and Fuches retire from the contract killing industry and start competing flower shop businesses.  Despite their lack of experience with keeping anything alive, the businesses are successful and expand rapidly.  To attract and retain talented employees, both businesses sponsor 401(k) plans with a safe harbor match.  Unfortunately, the economy enters into recession and the businesses slow down.  Fuches decides to sell his business, Fuches Flowers, to a competitor and, at the insistence of the buyer’s ERISA attorney, terminates the Fuches Flowers 401(k) Plan just before the sale.  Barry carries on Berkman’s Botanicals, but to reduce costs, Barry decides to “kill” (Barry’s term, not mine) the BerkBot 401(k) Plan’s safe harbor match a month into the current plan year and provides notice to all participants that the safe harbor match is dead effective immediately.   When Barry’s third-party administrator finds out about the untimely demise of the safe harbor match, they nervously let Barry know that there may be a problem.

Problem?  Forget about it.

Treasury Regulation § 1.401(k)-3(e)(1) generally requires that a safe harbor feature for a 401(k) plan be in place for a full 12-month plan year.  If a plan is operated as a safe harbor plan, failure to provide the safe harbor contribution for the full 12-month plan year generally results in a failure to satisfy Internal Revenue Code (“Code”) §§ 401(k)(12), (13), and Treas. Reg. § 1.401(k)-3.   Fortunately for Fuches, even though Fuches Flowers failed to provide advance notice of the Fuches Flowers 401(k) Plan’s termination to its participants, Treas. Reg. § 1.401(k)-3(e)(4)(ii) permits a safe harbor 401(k) plan to be terminated mid-plan year where the termination occurs in connection with the sale of the business that sponsored the plan (to an unrelated buyer).  Barry has no such luck.  Treas. Reg. § 1.401(k)-3(g)(1)(i)(A) permits a safe harbor match to be suspended by a business operating at an economic loss or where the safe harbor match notice permitted the plan sponsor to suspend the safe harbor match with at least 30 days advance notice to the plan’s participants.  Although Barry’s business has slowed down, it is still operating at a small profit and the safe harbor match notice for the plan year did not include a statement permitting the suspension of the safe harbor match with the 30-day notice to the participants (i.e., a “Maybe Not” Notice). No loss and no notice mean no suspension, much to Barry’s dismay.

After consulting with his lawyer, Barry informs all participants that the safe harbor match has been revived and that the safe harbor match will apply to all elective deferrals for the plan year.  Barry’s lawyer notices that a few participants reduced their deferral elections after receiving notice of the safe harbor match suspension.  Barry’s lawyer advises that an appropriate correction for this mistake would be to provide Qualified Non-Elective Contributions (“QNECs”) (that is, fully vested employer contributions) to each participant equal to the additional deferrals that would have been made but for the suspended safe harbor match.  Barry grows angry and his lawyer, having some knowledge of Barry’s prior career, becomes nervous. Barry’s lawyer explains that the QNECs would be based only on the month-long period during which the safe harbor match had been suspended.  But, just as Barry’s anger subsides, his lawyer points out that the QNECs should be adjusted (i.e., increased) to account for the investment earnings that would have been earned if the deferral rate had not changed.  Barry’s lawyer moves his chair a few inches away from Barry and further explains that Barry should also contribute an amount equal to the safe harbor match that the affected participants would have earned on the deferrals he is replacing.

Under the BerkBot 401(k) Plan, safe harbor matching contributions are made on a payroll basis (as opposed to a plan year basis) and are not subject to a “true-up” contribution at the year-end.  Under these circumstances, the safe harbor match must be deposited by the end of the plan-year quarter following the plan-year quarter in which the safe harbor match was earned.  Barry’s lawyer senses Barry’s spiraling frustration due to the additional costs to correct a measure taken to save money.  Fortunately for Barry’s pocketbook and perhaps his lawyer’s health, the mistake was discovered only one month after it occurred (and two months into the applicable plan year); Barry’s lawyer explains that no earnings adjustment is necessary with respect to the additional safe harbor matching contributions so long as the contributions are deposited by the end of the following plan-year quarter.

Conclusion

Employers may have good reasons to suspend safe harbor contributions or terminate a safe harbor plan mid-year, but the Code and Treasury Regulations limit the circumstances under which this is permitted.  Fortunately for Barry and his lawyer, the error was caught early and easily corrected.

If you or a client needs help determining whether it is appropriate to terminate their safe harbor contributions mid-year, please contact us.  After all, we are your ERISA solution!