The Not-So-Safe-Harbor 401(k) Plan

In a recent presentation, Monika Templeman (IRS Director of Employee Plans Examinations) announced that it has come to the attention of the IRS that a number of safe harbor 401(k) plans may not be in compliance.  As a result, they are planning a audit initiative to investigate the matter.  You may be asking what many have asked me on numerous occasions…“So, what?  Safe harbor plans get a free pass, what compliance issues are there to worry about.”The reality is that the rules that apply to safe harbor 401(k) plans can be more stringent than those that apply to regular plans.  While safe harbors provide a free pass on the ADP test and sometimes the ACP test and top-heavy requirements, it comes at a price.  Let’s take a quick look.Mandatory Safe Harbor ContributionOne of the fundamental requirements of a safe harbor plan is that the employer is required to make either a matching or non-elective contribution on behalf of eligible non-highly compensated employees, and the formula must follow what is written in the plan document.  This means no cutting back during slow economic times and no trueing-up matching contributions for HCEs who front load their deferrals when the plan calls for a pay period match.The safe harbor rules require that contributions be deposited no later than the last day of the year to which the contributions relate, e.g. December 31, 2012, for the 2011 safe harbor contributions.  For safe harbor match plans that calculate the match on a frequency other than annually, the match must be deposited no later than the end of the quarter following the quarter to which the match relates.  Deposits made after these deadlines represent compliance failures that can subject the plan to penalties.Top Heavy Minimum ContributionA common misperception is that the safe harbor relief from the top heavy requirements is absolute.  There are some common fact patterns in which a top heavy contribution may still be due.  Consider two quick examples.A top heavy plan provides for immediate eligibility to make deferrals but requires a waiting period for safe harbor eligibility.  Those eligible to defer but not to receive the safe harbor contribution are not covered by the top heavy relief, so the employer must make the 3% top heavy contribution.A top heavy plan includes a profit sharing provision.  Since the top heavy relief is conditioned on the only contributions being deferrals and safe harbor contributions, that relief is lost for the entire plan for any year for which a profit sharing contribution is made.These issues typically arise with safe harbor match plans when participants who defer less than 3% of pay don’t receive an employer contribution of at least 3%.  However, there can be issues even with higher deferral rates and with safe harbor nonelective plans.  The reason is that plans can use alternative definitions of compensation, e.g. compensation from plan entry, to calculate the safe harbor contribution, but the top heavy contribution is required to be calculated using full-year compensation.AmendmentsWhen amending safe harbor plans, timing is critical.  A few years ago, the IRS published guidance indicating that it is ok to amend a safe harbor plan mid-year to add a Roth feature or to provide for hardship distributions.  Some interpreted this as being a partial list and believed that other types of changes were also permitted as long as they made the plan more generous.  However, at the 2011 ASPPA Annual Conference IRS Q&A Session, one of the panelists indicated that the guidance on adding Roth and hardships is pretty much an exclusive list, meaning that no other changes are permitted once the year begins.  No accelerating eligibility requirements; no increasing the deferral limit or adding catch-up contributions; no changing your safe harbor match from pay period to annual.To those who might be tempted to skip the annual compliance review on a safe harbor plan, I will remind you of the adage that an ounce of prevention is worth a pound of cure.  The IRS is coming to a safe harbor plan near you, and fixing any problems on your terms is far preferable to waiting for them to show you that your safe harbor plan isn’t quite as safe as you thought.
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