IRS May Relax 401(k) Rule for Troubled Firms

The Internal Revenue Service is taking steps to ease financial pressures on companies that make automatic 401(k) plan contributions under a safe harbor provision that allows them to avoid nondiscrimination testing.

In a proposal published Monday, the IRS said that employers that automatically contribute the equivalent of 3 percent of employees’ pay to workers’ 401(k) plan accounts—to avoid nondiscrimination tests—could suspend those contributions if they incur a substantial business hardship.

Employers, though, would have to meet numerous criteria set by the IRS, including ensuring that their 401(k) plan passes the nondiscrimination test.

Under federal law, employers do not have to run an IRS nondiscrimination test—used to determine whether average salary deferrals of higher-paid employees exceed those of rank-and-file employees by a legally set amount—if their plans qualify for certain safe harbors.

To qualify for one safe harbor, an employer has to match 100 percent of employees’ deferrals up to the first 3 percent of pay and match 50 percent of deferrals made on the next 2 percent of pay.

Employers that automatically enroll employees in 401(k) plans also are exempt from nondiscrimination testing if they fully match employees’ salary deferrals on the first 1 percent of pay and 50 percent of deferrals on the next 5 percent of pay.

The rule the IRS published Monday, May 18, would affect safe harbor provisions for employers that automatically contribute an amount equal to at least 3 percent of pay into employees’ 401(k) plans.

Previously, the IRS allowed employers that qualified for the matching safe harbor to suspend the contribution if they incurred a substantial business hardship. The latest proposal would extend that relief to employers that qualify for the safe harbor through automatic employer contributions.

If adopted, the rule, published in the May 18 issue of the Federal Register, would apply to plan years beginning after December 31, 2009.

Benefits experts welcomed the proposed change.

“Companies that are really suffering right now will be more likely to be able to keep their plans,” said Anne Waidemann, a director with PricewaterhouseCoopers in Washington.

Filed by Jerry Geisel of Business Insurance, a sister publication of Workforce Management. To comment, e-mail editors@workforce.com.

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