Safe Harbor 401(k): A Quick Guide

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Is a Safe Harbor 401(k) Plan right for your business? 

There are several types of 401(k) plans and features available to employers that have different rules, requirements, and advantages. It is important for employers to be familiar with the details of plan options so that they can make the best choice that supports their company goals as well as their employees’ retirement.

So, what makes a Safe Harbor different than the rest? Let’s jump in.    

What is a Safe Harbor 401(k)?

A Safe Harbor 401(k) plan is similar to a traditional 401(k) plan. It’s an effective tool for promoting financial security in retirement, attracting and keeping talented employees, and offers tax advantages.

A Safe Harbor 401(k) plan must provide for employer contributions that are fully vested when made. These contributions may be employer matching contributions, limited to employees who defer, or employer contributions made on behalf of all eligible employees, regardless of whether they make elective deferrals.

​A Safe Harbor 401(k) plan is not subject to the complicated annual nondiscrimination tests that normally apply to traditional 401(k) plans.

Fully vested means that participants have ownership rights to all of their retirement funds, including all employer contributions. When someone is fully vested in a retirement plan, they have 100% ownership of the funds in their account. This happens at the end of the vesting period.

Benefits of a Safe Harbor Plan

  • Reduce plan maintenance by eliminating annual testing requirements and the obligation of maintaining a vesting schedule
  • Maximize deferrals for highly compensated employees
  • Balance a plan’s top-heavy status
  • Provide additional employee benefits with profit-sharing or matching contributions
  • Encourage participation and discourage turnover with employer contributions and immediate vesting

The Safe Harbor 401(k) is ideal for employers who wish to eliminate the burden of the discrimination testing associated with the traditional 401(k). Under these tests, there can’t be a large discrepancy between the groups in terms of what they are depositing into their 401(k) accounts. 

For example, with the ADP test, if non-highly compensated employees are only putting an average of 4% of their income into their retirement plan, highly compensated employees may be limited to depositing 6% of their income. 

The government-required tests aim to assess whether the account contributions are top-heavy. To do that, the tests compare the fund assets of key employees to those of everyone else. With a Safe Harbor component, highly compensated owners don’t have to worry about their contributions being capped by ADP testing. 

With a regular 401(k), a company must pass the nondiscrimination testing every year, but plans that follow the safe harbor framework are assured of fulfilling government requirements. What’s more, highly compensated owners don’t have to worry about their contributions being capped by ADP testing. 

A plan is top-heavy when the owners and most highly paid key employees own more than 60% of the value of the plan assets. This ratio is tested every year based on the account balances on the last day of the prior plan year. If the plan is considered top-heavy then corrective action may be required.

The trade-off is the company has to make mandatory contributions to employee 401(k) accounts, and that money becomes vested immediately. For a large company, that could be an expensive proposition, but a small business may find it is more cost-effective to make retirement contributions than deal with burdensome nondiscrimination testing.

Types of Safe Harbor Plans

Safe harbor 401(k) plans can be set up with or without a match. The following are the available 401(k) safe harbor match and contribution options:

  • Basic Safe Harbor: Also known as an elective safe harbor, this plan will match 100% of contributions up to 3% of an employee’s compensation and then 50% of an employee’s additional contributions, up to 5% of pay.
  • Nonelective Safe Harbor: With these plans, employers make a 3% retirement contribution for all workers, regardless of whether they choose to participate in the plan.
  • Enhanced Safe Harbor: As another type of elective plan, enhanced safe harbor 401(k) plans meet or exceed what is offered in a basic plan. Typically, they provide a 100% match of up to 4% of an employee’s compensation.
  • QACA Safe Harbor: Standing for qualified automatic contribution arrangement, QACA plans feature automatic enrollment that puts aside 3% of a worker’s compensation in the 401(k) plan unless they opt-out. There is also a requirement for an auto-increase of 1% per year until the deferral rate reaches 6%. Employers usually match 100% of the first 1% of contributions and 50% of deferrals between 1% to 6% of compensation.

When Should Your Company Consider a Safe Harbor 401(k)?

Safe harbor plans are beneficial for both employers and employees, but there are certain circumstances when safe harbor plans are even more advantageous to protect your company:

  • If your company’s 401(k) plan has recently failed non-discrimination or compliance tests and you want a stronger guarantee of performance in the future.
  • Your company’s highly compensated employees want to be able to contribute more to the 401(k) plan without risking non-discrimination testing failure.
  • Your current plan is “top-heavy,” or has 60% of more of the plan assets allocated to key employees.
  • Your current 401(k) plan has a low level of engagement among your non highly compensated employees due to factors such as personal financial insecurity or an inability to contribute.
  • You have recently been required to make employer contributions to keep your plan passing or compliant.

Safe Harbor 401(k) provisions can only be added to an existing plan before the beginning of the plan year, and they must be in effect for the entire year. These provisions cannot be changed or eliminated during the year, except if the plan is terminated.

In the event of termination, the Safe Harbor 401(k) contribution up through the date of termination would still apply. Make sure you allow sufficient time for the plan to set up, complete all administration documentation, and set up account deposit arrangements.

Want to optimize your current 401(k) plan but don’t know where to start? 

The first step is to review your current plan with a professional. 

Sign up for a complimentary 401(k) Benchmark below, and one of our expert advisors will be touch shortly.

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