KEYWORD:

EMPLOYEE BENEFITS MEMORANDUM

Date:	January 20, 2000
Re:	Safe Harbor

This is the text of a letter written by France King Quick on January 20, 2000 concerning Safe Harbors relating to 401(k) and 401(m).

The IRS has updated its previous guidance on the design-based 401(k) “safe harbor” alternatives for satisfying the 401(k) and 401(m) nondiscrimination tests. IRS Notice 2000-3 modifies the guidance provided in Notice 98-52, and has additional pro-safe harbor rules which are designed to, and will, encourage their use.

As a brief refresher, Code § 401(k)(12) and (m)(10) added alternative matching and nonelective contribution methods of satisfying the ADP and ACP tests for years after 1998. The basic two-tiered matching ADP test safe harbor formula provides matching contributions on behalf of each eligible non-highly paid employee (“NHCE”) equal to 100 percent of the first 3% of elective contributions, and 50% of the next 2% of elective contributions. This means the total basic match is 4% of the employee’s compensation. Notice 98-52 describes an “enhanced matching formula” which permits the match for each eligible NHCE to exceed the basic match, provided the aggregate match at any given rate is at least equal to the required match under the basic matching formula at the same level. The nonelective contribution method requires at least a 3% contribution for every eligible NCHE.

The Notice has two pieces of good news for safe harbor procrastinators. First, if your plan year begins between January 1, 2000 and June 1, 2000, a new transition rule will permit you to give a “late” notice. If you adopt a 401(k) safe harbor method for the first time in 2000, you may give your required notice – which normally must be given at least 30 days before the plan year begins – by May 1, 2000. The safe harbor contribution – whether it’s a match or a nonelective contribution – must still be made for the entire year, but this essentially gives you another two or three months to decide if a safe harbor plan is right for you.

I’ve been calling the second helpful new rule the “December 1” rule. The December 1 rule says, for the nonelective contribution safe harbor only, you have until 30 days before the end of the current plan year to adopt a safe harbor plan for that year. This means you can wait until the year is nearly over to decide whether you want to make a 3% contribution and dispense with ADP testing for that year. If you generally make a profit sharing contribution to your plan, and can live with the automatic vesting/no last day of the plan year rule/no 1000 hour requirement, you may want to reserve the right to decide in the latter part of the year whether to use some of your profit sharing contribution as a 401(k) safe harbor nonelective contribution. Remember, the general rule is you must adopt the safe harbor method before the beginning of the year (subject to the NBJPA remedial amendment period). Taking advantage of the December 1 rule does not obligate you to use it in subsequent years, and there is no limit on the number of years you to can do this. One cautionary note: You will have an additional notice requirement with the December 1 rule since you still have to tell the participants at the beginning of the year you are reserving the right to amend the plan by December 1 (or within 30 days of the plan year end); then, you must give a second 30 day notice if you decide to use the safe harbor.

The new guidance also does the following:

Eliminates the original year-end “true-up” calculation on the match by permitting matching contributions on the basis of compensation for a payroll period, month or quarter.
Makes it clear that a safe harbor plan can require elections to be made using whole percentages of pay or whole dollar amounts.
Allows the safe harbor plan to match an employee’s aggregate elective and employee contributions.
Makes clear that your safe harbor plan may require a 12-month suspension of employee after-tax contributions similar to the 12-month suspension that may be applied to elective contributions after an in-service withdrawal of the contributions.
Permits the plan sponsor of a safe harbor plan to exit the safe harbor during the plan year and switch to ADP and ACP testing if the employees are notified beforehand.
Clarifies that a 401(k) safe harbor plan may separately test a group of plan participants who do not meet the minimum age and service conditions permitted under Code § 410(a). The plan must specifically provide, however, that elective contributions and any matching contribution for the otherwise excludable group will satisfy the ADP test and, if applicable, the ACP test.
If a CODA is added to an existing plan for the first time during a plan year, the plan may be a safe harbor plan for that year, even though the requirements are not satisfied for the entire year, as long as the CODA is made effective no later than 3 months prior to the end of the plan year.