A Change in 401(k) Safe Harbor Plans

In May, the Internal Revenue Service made a change allowing companies that offer a particular variety of so-called safe harbor 401(k) plans to suspend contributions to those plans for the rest of the year. But doing so will trigger a series of tests, and failing them might mean a company has to make its 401(k) contribution anyway. "This has some potential gotchas," warns Ben Norquist, president of Brainerd (Minn.)-based consultants Convergent Retirement Plan Solutions.

The IRS change applies to financially distressed companies offering a particular type of safe harbor plan, one that gives all eligible employees a 3% contribution whether or not they kick in their own money. Previously, the inability to pony up the 3% meant dropping a plan entirely.

But suspending contributions to a safe harbor plan means that if a company's high earners are contributing, on average, a lot more than the rest of the team, the company needs to return some of the high earners' money, triggering a tax hit for the affected employees. And if 60% or more of a plan's assets are held by top managers or company owners, the plan is deemed "top-heavy." In that case, the company must make a 3% contribution to every eligible employee—exactly the payment it wanted to avoid in the first place.

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