Employer's 401(k) plan complies with a matching safe harbor formula of 100% match on the first 3% of pay deferred + 50% match on the next 2% of pay deferred. Employer decides to increase the match during the plan year to 100% match on the first 5% of deferrals. Employer is willing to comply with any applicable notice requirements.

My initial impression was that a mid-year increase of matching contributions would cause the plan to no longer comply with the safe harbor requirements for that plan, instead necessitating that the plan be subject to ADP / ACP testing. However, upon closer inspection (and following discussion with legal counsel), the ramifications might be even worse. Treas. Reg. 1.401(k)-3(e)(1)(2nd sentence) states:

In addition, except as provided in paragraph (g) of this section, a plan which includes provisions that satisfy the rules of this section will not satisfy the requirements of § 1.401(k)-1(b) if it is amended to change such provisions for that plan year.

In other words, if one amends the plan to change the provisions of the plan that satisfy the safe harbor rules effective for that plan year and if the change is an increase, not a suspension or reduction of the match permitted by 1.401(k)-3(g), then the ADP test is not satisfied.

I had read the preambles to both the proposed and final versions of the 401(k) / 401(m) regulations and do not see anything that addresses mid-plan year increases in matching contributions. I also found nothing relevant in recent IRS gray books. We can't avoid dealing with the regulations as they are written.

Help me decide between two possible interpretations:
(1) Employer cannot increase the matching contribution in the middle of the plan year. There are some other possible solutions described below.
(2) Amend the plan to add in the additional layer of match (50% on deferrals in excess of 3% of pay but not exceeding 5% of pay) but don't amend any of the plan provisions describing the safe harbor match already in the plan. Now, the sentence in the regulation I quoted doesn't apply, right? [Query: might this interpretation go too far? Does the plan still meet the safe harbor rules so that ADP / ACP testing isn't required? Although it would be prudent to notify employees, is that technically required?]

Other work-around solutions:
- Wait until the beginning of the next plan year obviously.
- Change the plan year in compliance with the rules in the safe harbor portions of the 401(k) / 401(m) regulations.
- If one anticipates this happening in advance, use the discretionary match rules in the safe harbor portions of the 401(k) / 401(m) regulations, although to avoid having a higher rate of match available to an HCE than is available to any NHCE, the discretionary match probably has to be made for the whole plan year or exclude HCEs from the discretionary match.

FYI, I searched and found some prior threads on related topics, but none that addressed my question exactly:
http://benefitslink.com/boards/index.php?showtopic=29756
http://benefitslink.com/boards/index.php?showtopic=9518

Thanks in advance for any replies.

There would normally be a provision for additional discretionary matching (that satisfies the ACP safe harbor) that is done in addition to the Basic Safe Harbor Matching.

The idea of increasing the actual Safe Harbor Matching during the year is an ABSOLUTE NO-GO. The problem is that the notice that would have been provided by 30 days prior to the beginning of the plan year did not reflect the increased match. If it had, it may have induced those who have failed to contribute to contribute by now. So, you cannot change after the notice of the amount that will be provided has been issued.

Hope this helps.

Not having done any research or reading, my thought process would be that you could not increase the match from the standard to 100% of 5% for the year. My thought is that you have not properly notified the employees of the match. For example, some may have elected only 3% based on wanting to receive $1 for $1. If they had known that 100% of 5% would be the case than they may have elected 5% instead of 3%. Also, what about those who terminated prior to this amendment. I think it would be discriminatory for them as well. Evan if you disagree with this or find a way around it, I do not know how you would get around the notice requirement. I do not think that a notice can be made during a year unless it is to (i) establish a safe harbor or (ii) terminate a SH match.

Two other thoughts:

1) They can simply make the match as a discretionary match after the end of the year. It could be 100% of first 1%. This should allow them to maintain both ADP/ACP safe harbor statuses.

2) I would tell them that they will have to wait to change the match for the following plan year.

Hope this helps.

at the meeting I had a few weeks ago with the IRS they frowned upon such practice of changing a match during the year - regardless of whether the match was safe harbor or discretionary. if match is done on a payroll basis (as opposed to match which is deposited throughout the year, but with a true up at the end), then the rate of match becomes a problem.
even if it was a match with a true up, and the match was increased you can still have problems.
arguments were omething like this:
someone who received a match earlier in the year and terminated might have deferred more if he knew the match was going to be greater. in a similar vein, at this late date, someone might have deferred more if they knew the match was going to be greater, but can't take full advantage as of this late date. etc., etc.
I believe this will be discussed in greater detail at the ASPPA conference, but you never know how much time they have to discuss things at the Q and A session.

Tom-- Would that concern also apply to prospective match increasess, where what employees would have done in the past doesn't apply?

General comments about a mid-year safe harbor match increase . . .

I have no quibbles, but let's think about the big picture a minute.

What if the increase is prospective only, and sufficient notice is given allowing changes in deferral elections, and the employer understands that safe harbor status is no longer going to apply for that year? I ask that question because, based on this discussion and the regs, I find it curious that the safe harbor match can be prospectively suspended or reduced during the year if the ADP test is performed for the whole year, but that apparently a prospective increase is not permitted. (Treas. Reg. Section 1.401(k)-3(g).) Why is that so?

What would happen if a prospective increase in the match were instituted and employees had the opportunity to adjust their deferrals to the new prospective match? If the only consequence is the loss of safe harbor status, any idea why that situation wasn't discussed in the above-cited reg.? It certainly can't be "forbidden"? And, if the plan has a 6% fully vested non-elective safe harbor contribution, what's the harm to anyone if it's reduced to 3% prospectively (assuming you give the equivalent of a 204(h)-style notice discussing the prosepctive reduction of the "promised" employer contribution))? And why wouldn't this non-elective reduction be permitted to retain safe harbor status (aside from the cited reg.)?

What's the story behind the story? How does this all fit together?

I think these provisions result from IRS concerns about potential abuses. The rationale for one of these rules is addressed in the preamble to the final regs:



Sieve,

In your case of starting with a 6% non-elective and then prospectively changing to 3% during the year, do you think they should still be able to keep the safe harbor if the change is made effective after the owner's comp reaches $230,000 for the year?

Kevin --

That's a great quote. (Let me qualify that: that's a great quote only within the context of this 401(k) discussion . . . )

Maybe the sentence in the regs. referred to earlier (Treas. Reg. Section 1.401(k)-3(e)(1), 2nd sentence) is to be read to fit in with that preamble language. In fact, I suspect (without going over the regs with a fine-tooth comb) that the premable quote specifically refers to this sentence and to paragraph (1). That might mean that the reg language "if it is amended to change such provisions" (my emphasis)means that we're talking about a prohibition from changing "provisions which satisfy the rules of this section [i.e., the -3 regs re: safe harbor plans]" (again, my emphasis)--meaning that eliminating a safe harbor is not permitted, but adding to a safe harbor is ok because is still satisfies the requirements of the -3 regs. (Would that mean that I think the reg might allow a change from a match SH to a non-elective SH in the same year? Yes, but abuse would be protected by other IRS non-SH rules.)

To me, that explanation mkes more sense because it would (i) permit a change that stays within safe harbor rules (i.e., allows for a match or non-elective going forward which meets minimum safe harbor allocation rules), as long as it meets any other IRS rules (in the event it is a cutback in allocation or contribution) (ii) would explain why the only changes discussed in -3(g) relate to reduction or elimination of a safe harbor (i.e., moving from within safe harbor to outside of safe harbor) and do not discuss changes which retain the plan's safe harbor status or that increase an allocatin or contribution rate, and (iii) would be consistent with the language of the preamble.

But, I'm probably stretching with this analysis. Still I think decreases (which still meet safe harbor rules after the decrease) can be kept from being abusive through other provisions (such as anti-cutback, perhaps), as can increases. I think the solution of the reg in preventing potential abuses clearly is overbroad if it prevents the change noted in the OP.

As to your question--I would have a problem with that set of facts. My problem is a discrimination issue, however, and not a safe harbor issue. I probably would solve it by determining the HCE's 401(a)(17) comp with respect to each portion of the match on a pro rata basis, so that if 20% of total comp (unlimited by 401(a)(17)) was earned after the change to 3%, then 20% of the 401(a)(17) limit would be matched at 3%. A jury-rigged answer, perhaps, but it's just like the proration we already perform for compensation earned by an employee who is over the 401(a)(17) limit when his/her controlled group comp. is aggregated and then allocating that comp to multiple plans among the controlled group members.

I think I understand why the IRS did it that way. Can you imagine trying to write regulations that would allow mid-year increases, but still prevent abuses by creative plan sponsors? It's much easier and much cleaner to just say you can't change the safe harbor provisions during the year.

On your compensation proration solution, I don't see how you could do that during the year. At 6/30, how do you know what % of his total comp he has received so far if you don't know for sure what his total comp will be?

Well, Kevin, the 401(k) regs already have an overriding anti-abuse provision which isn't very specific but arose because abuses that weren't considered began coming to light (1.401(k)-1(b)(3)). And Congress, with 414(o), gave Treasury authority to protect against unseen abuses with very general language. My contrarian nature tells me the SH issue could have been handled somehow.

But, be that as it may, your analysis is probably correct--and, I'm sure Treasury's approach is probably based somewhat on the realization that it's easier to regulate by changing a conservative approach to a more liberal one rather than the other way around.

Agreed: without a true-up, my solution re: allocating a mid-year change in match would not even have a chance of working. And, I assume you could add a true-up in mid-year if the Plan language provided each employee with the greater of the payroll-based match or the true-up match.

Thanks for the many thoughtful responses. My initial post was so long and technical that I wasn't sure whether it would draw responses, especially since I've not been active on these message boards for a long time.

Summarizing what you've said so far ...

It sounds like the objections focus on:
- The fact that the notice didn't describe the possibility of a match increase. Perhaps this could be fixed before the notice went out, but if one knows of the possibility of an additional match way back then, then amending the plan to allow a discretionary match is a better approach.
- The fact that an HCE might have a higher match rate available to him/her than what is available to an NHCE when the match increase takes place partway through the year. In that case, perhaps one makes the match retroactively effective for the full year of excludes HCEs from the extra match for the remainder of the first plan year. Another view is that simply implementing the match partway through the year violates the first sentence of Treas. Reg. 1.401(k)-3(e)(1) so the plan isn't safe harbor anymore (because an HCE may have a higher match rate for the year than an NHCE) but doesn't violate the second sentence of that paragraph (the one I quoted in the original post) so that ADP/ACP testing is permitted.
- Concerns that the IRS objects to this as a matter of policy, based on comments in the preamble that Kevin quoted and informal statements such as what Tom Poje reports.

No one has really shouted down the technical argument I advanced that we've not amended the provisions that comply with the safe harbor rules, but there are some other tricky obstacles, which I've enumerated.

If you are intending to have the additional match be included in the ACP safe harbor, I would say that adding the extra match is amending your safe harbor provisions during the year, which I interpret the regs as prohibiting.

If you are intending to add an additional match that will be subject to ACP testing, then I would say you are not amending safe harbor provisions.

For next year, add a discretionary match that complies with the SH rules to the plan along with the existing SH match.

Here's what I'm intending.

The plan provisions adding the additional match were not adopted before the plan year began, so the plan would not meet the ACP test safe harbor under Reg 1.401(m)-3(f)(1)(first sentence). However, the amendment layered on an extra match but didn't amend the existing safe harbor provisions, so (I'm arguing) the second sentence of that regulation is inapplicable. The result is that the plan lost the ACP safe harbor status but that it may run an ACP test.

Wouldn't that also mess up your ADP safe harbor?

Why not just add a regular match in addition to the SH match and use 1.401(m)-2(a)(5)(iv) to give you more flexibility in your ACP testing? If you are not amending your safe harbor provisions, you should be able to retain the ADP safe harbor.

Yes, I think it will mess up both the ADP and the ACP safe harbors. I've been quoting 1.401(m)-3(f)(1), but the 401(k) regulations have a parallel provision in 1.401(k)-3(e)(1). I think under the first sentence of those regulations, the ADP and ACP test safe harbors are lost. I'm hoping though that the second sentence of those regulations are inapplicable so that I am allowed to perform ADP / ACP testing. I've been trying to distinguish between the two sentences. Maybe the better argument is that I've satisfied the first sentence too, that safe harbor provisions were adopted before the plan year began and remained in effect for the entire 12-month plan year.

I read the first and third sentences Reg. 1.401(m)-2(a)(5)(iv) as applying to a situation where the plan meets the ACP safe harbor and the second and third sentences of that provision as applying to a situation where the plan meets the ADP but not the ACP safe harbors. I don't see that that regulation contemplates an outcome where some of the match satisfies the ACP safe harbor but other matching contributions don't satisfy the ACP safe harbor.