The IRS has issued a proposed rule to allow employers sponsoring safe harbor non-elective plans to suspend such contributions at the beginning of a plan year if a substantial business hardship occurs and if other conditions are satisfied. Safe harbor plans include:

Traditional safe harbor non-elective (employer) contribution

The easiest approach to satisfy 401(k) nondiscrimination rules is to establish a safe harbor non-elective (i.e., profit-sharing) contribution. Under this approach, all eligible employees receive an employer contribution, equal to 3% of compensation, that is 100% vested.

As a result, the ADP/ACP tests are not required, and the 3% top-heavy contribution also is satisfied for plans where more than 60% of all account balances belong to key employees. To establish a safe harbor profit-sharing plan, all employees must receive the 3% contribution, and allocations may not be limited to those who work 1,000 hours or are employed on the last day of the calendar year. Additional rules:

* Eligible participants must receive a written notice stating the ability to receive an employer contribution at least 30 days and not more than 90 days before the beginning of each plan year. This notice must be provided for each year the plan will be a safe harbor plan.

* Employers may withdraw the safe harbor contribution prior to Dec. 1 of the plan year.

* Safe harbor contributions are not available for in-service distributions before age 591/2.

* Safe harbor contributions may not be integrated with Social Security benefits.

* The safe harbor contribution must be provided to all eligible employees.

* The employer contribution either may be a guaranteed contribution or a flexible contribution. The guaranteed contribution requires employers to make contributions each plan year, unless they amend the plan and remove the provision before the start of the next plan year. The flexible profit-sharing contribution allows employers to decide annually whether to provide a contribution. Under this option, employers provide a conditional notice as indicated above, 30 to 90 days before the start of each plan year, in which the employer states it may make a safe harbor contribution. No later than Dec. 1 of each plan year, employers must provide another notice indicating if the safe harbor has been elected and if the contribution will be made.

* If the employer contribution is made, discrimination testing for the ADP/ACP tests is not required. If the contribution isn't made, the tests must be performed.

Matching contributions

As an alternative to an employer non-elective profit-sharing contribution, a safe harbor plan may provide for a 100% vested matching contribution. The basic safe harbor matching contribution is 100% of the first 3% of employee savings contribution, and a 50% matching contribution on deferrals between 3% and 5%. Thus, the maximum matching contribution will be 4% of compensation.

As an alternative, employers may choose an enhanced matching contribution formula equal to 100% of the first 4%. The enhanced matching contribution may not increase as the percentage of deferrals increases, and the rate of match for highly compensated employees may not exceed the rate of match for non-highly compensated employees.

The amount of the safe harbor matching contributions must be described in the annual notice provided to all eligible participants each year.

PPA auto-enrollment safe harbor plan

In lieu of the above safe harbor plans requiring 100% vesting, the Pension Protection Act established a new automatic enrollment safe harbor plan. Under this provision, a plan is required to have certain automatic employee contributions, which may be waived by participants. Employees are also required to become 100% vested in all matching contributions after two years, rather than the immediate vesting rule that applies to other safe harbor plans.

Employees are required to be automatically enrolled at a level of 3% for the first plan year, 4% in the second, 5% in the third and 6% in any subsequent plan year. Employers are required to provide matching contributions equal to 100% of the first 1% of deferrals and at least 50% matching contribution on the next 5% of employee savings contributions.

Thus, if an individual makes an employee savings contribution equal to 6% of compensation, they will receive a 31/2% matching contribution. As an alternative, an employer may simply make a 3% non-elective profit-sharing contribution, which is also subject to the two-year vesting schedule. To establish a safe harbor plan, participants must receive annual notice before Dec. 1.

Relief for mid-year changes

One of the primary difficulties with safe harbor plans is that after employers establish such a plan, they could not change the contributions that have been promised to employees. Although it is possible under prior IRS rules to discontinue the safe harbor matching contributions during a plan year, or to revoke a contingent non-elective profit-sharing contribution, the IRS previously has been reluctant to permit employers to terminate a promised 3% contribution. An employer could only eliminate the 3% safe harbor contribution by terminating a plan.

In recognition of the current financial strain many employers are under, effective May 18, under the proposed new rules employers may eliminate the 3% employer contribution if certain conditions are satisfied, which generally are comparable to provisions relating to reducing or suspending a safe harbor matching contribution. To obtain this relief employers must incur a "substantial business hardship" and satisfy the following conditions:

* All eligible employees are provided a supplemental notice of the reduction or suspension of the employer contribution.

* The reduction or suspension of safe harbor employer contributions is effective no earlier than the later of 30 days after eligible employees are provided the supplemental notice and the date the amendment is formally adopted.

* Eligible employees are given a reasonable opportunity prior to the reduction or suspension to change their employee salary deferral contributions.

* The plan is amended to provide that the nondiscrimination tests will be satisfied for the entire plan year in which the reduction or suspension occurs using the current year testing method.

* The plan satisfies the safe harbor non-elective contribution requirement, with respect to compensation paid through the effective date of the amendment.

The supplemental notice requirement is satisfied if each eligible employee is given a notice that explains the consequences of the amendment reducing or suspending future safe harbor employer contributions, the procedures for changing salary deferral elections and the effective date of the amendment.

Fundamental to suspending an employer non-elective contribution is the existence of a substantial business hardship. Factors to use in determining a hardship include operating at an economic loss, substantial unemployment in the employer's industry and depressed or declining sales and profits.

Employers who follow the above rules to suspend an employer contribution will, however, still be required to make top-heavy contributions if necessary.