A Safe Harbor 401(k) plan allows employers to avoid certain IRS non-discrimination tests for their plan. Basically, if the employer is willing to make certain 401(k) contributions on behalf of employees they will no longer be subject to certain tests which limit the ability of their highly-compensated employees (“HCE’s”) to contribute to the plan. If you’re already making a contribution or match, you may redeploy those funds to receive a higher value. If not, this new contribution will effectively provide extra income to your employees via the 401(k) Plan. And, did we mention that IRS compliance just got much easier?
Okay, I’m interested, but what’s it cost?
A fair question. There are two different types of Safe Harbor contributions – you didn’t think the IRS would make this easy, did you?
Basic Match – the employer contribution is 100% of the 1st 3.0% of pay contributed by an employee plus 50% of the next 2.0% of pay contributed – so, the maximum employer contribution is 4.0% of pay. So, the employee must contribute to receive a benefit which may reach 4.0% of their pay.
Nonelective Contribution – each eligible employee receives a contribution of 3.0% of pay whether or not they contribute.
So, the answer is “it depends”. If a sizeable percentage of your employees are contributing to the plan and they are deferring at least 5.0%, the Basic Match option will likely cost more than the 3.0% of the Nonelective Contribution. But, if your employees are contributing that much, you’re likely not having issues passing nondiscrimination tests nor seeing returns of deferrals for your HCE group. So, for most employer, the Basic Match will be cheaper.
Which Safe Harbor Option should I choose?
To answer a question with a question – what are your goals? You want to make sure that this decision is consistent with your other objectives to ensure that you’re not simply adding costs.
Are you seeking to maximize total contributions for owners or HCE’s?
If so, you are likely using something called “New Comparability”. Assuming that, you should consider the Nonelective Contribution as that 3.0% contribution can be used to meet the “gateway” contribution under New Comparability and will allow you to meet your objectives at a lower cost.
Are you seeking shared responsibility for retirement?
If it’s important for you that employees contribute their own funds to receive any employer contributions, then the Basic Match is what you’ll likely choose.
Is your plan “top-heavy”?
If so, the 3.0% Nonelective Contribution will serve to meet the top-heavy minimum contribution so this may be a great option.
When do I need to make these Safe Harbor contributions?
You can fund the Safe Harbor contributions each pay-period, at the end of each month or quarter, or even annually so long as they are made by your tax filing deadline. The decision on when to make the contributions reflects a balance between cash flow needs/objectives and the human resource benefits of more frequent contributions to employee accounts.
Can I apply a vesting schedule to these contributions?
Alas, the answer is no. The IRS requires that these contributions be 100% vested immediately (e.g., the employee is entitled to the benefit as soon as it’s contributed/earned).
Can HCE’s & business owners receive these contributions?
Yes. For once, you get an answer you want. However, we’d suggest that you consider excluding “key” employees such as business owners from such contributions – you can make a comparable discretionary profit-sharing contribution on their behalf. If you never intend on making profit sharing contributions beyond the safe harbor, then feel free to include key employees as well.
Okay, Safe Harbor sounds good – how do I do it?
You’ll need to talk with your retirement plan consultant to update / amend your plan document to add this feature. For an existing plan, you will need to notify employees 30-90 days prior to the beginning of the plan year. So, for a calendar year plan, you’d need to send out notices no later than December 1st which means your plan would need to be amended prior to that time. Your retirement plan consultant should provide you a copy of this “Safe Harbor Notice” to provide to all eligible employees.
Interested in a Safe Harbor 401(k)?
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