By Mark Olsen, Managing Director at PlanPILOT
Contrary to popular belief, an employer-sponsored retirement plan is more than just a benefit for employees; there are actually many ways the plan sponsor can benefit as well. From attracting and retaining key employees to tax-deductible contributions and expenses, a retirement plan is a benefit that can work well for everyone involved.
Despite the benefits, it can be difficult to sort through all the information out there and truly know which plan is best for you and your business. It doesn’t have to be this way! We at PlanPILOT can help you sort through the many retirement options available to plan sponsors. In this guide, we’ll explore the pros and cons of the safe harbor 401(k) and how to decide if it’s the right option for you.
What Is a Safe Harbor 401(k)?
A safe harbor 401(k) is named after the “safe harbor” provision in the tax code which states certain alternative conduct will be considered compliant for a particular rule or requirement. In this case, a safe harbor 401(k) plan will be exempt from annual nondiscrimination testing as long as the employer makes fully vested contributions to every eligible employee’s account. (1)
Plan sponsors can choose which type of safe harbor plan they would like to adopt, which provides flexibility in finding a plan that fits your needs.
- Basic safe harbor match: (2) The employer must match 100% of employee contributions on the first 3% of compensation, then 50% of contributions on the next 2% of compensation. The matching contributions are only limited to employees who are actively deferring funds into the plan. This means you could contribute to fewer employees but you will probably contribute more per person.
- Non-elective safe harbor: (3) With this plan, employers will contribute 3% of all eligible employees’ salaries, regardless of whether the employees contribute themselves. In this case, you would contribute to a greater number of employees but less per person.
- Qualified automatic contribution arrangement (QACA): (4) This plan is also known as a safe harbor plan with an automatic enrollment feature. It is used to automatically enroll employees into the plan at a savings rate of 3%. The employer can then choose to make matching contributions or non-elective contributions at a reduced rate. The QACA match plan requires employers to match 100% of contributions on the first 1% of employee compensation, then 50% of contributions on the next 5% of compensation. The QACA non-elective plan, on the other hand, requires employers to contribute 3% of compensation to all eligible participants. Both plans require that employer contributions fully vest after two years, which is more favorable to plan sponsors and can be used to promote employee retention.
Pros
There are many benefits to a safe harbor 401(k) plan, including:
- Exempt from annual nondiscrimination testing: A safe harbor plan is considered compliant with the major annual tests (ADP, ACP, and top-heavy) as long as the mandatory contribution levels are met. This alleviates a significant administrative burden and expense on the plan sponsor’s side.
- Increased contributions: Since safe harbor plans are not tested for nondiscrimination, employers and highly compensated employees can both contribute more to their accounts without fear that the plan will be considered non-compliant.
- Tax-deductible contributions: Like other 401(k) plans, employer contributions are tax-deductible up to 25% of covered compensation paid, limited to $305,000 of compensation per employee. (5)
- Attract & retain employees: The required employer contributions are an attractive benefit to employees who are looking for long-term stability and growth within the company. This can help attract and retain top prospects.
Cons
While the benefits of a safe harbor 401(k) are enticing, it’s important to keep the cons in mind as well:
- Costly contributions: Choosing a safe harbor plan means you will be required to make employer contributions every pay period or at the end of each plan year. These can quickly add up, especially if you have a lot of eligible employees. If you don’t keep up with the contributions, your plan could lose its tax-qualified status, resulting in hefty fines and penalties.
- Immediate vesting: Unless you choose the QACA plan, safe harbor plans require immediate vesting of employer contributions. That means employees will automatically be entitled to 100% of the funds should they quit or get fired. This can make it easier for employees to leave, reducing overall retention rates.
- Annual administrative requirements: Safe harbor plans must deliver notice to plan participants every year, at least 30 days before the plan year ends. This notice must detail each employee’s rights and obligations under the plan. (6) Ensuring that notices are sent in a timely fashion can add an administrative burden to the plan sponsor.
Making the Right Choice
Choosing the right retirement plan offering, whether it’s a traditional 401(k) or a safe harbor plan, comes down to several factors, including employee count and demographic, participation levels, company cash flow, previous compliance issues (if any), and desired plan design.
At PlanPILOT, we help retirement plan sponsors sort through these factors to determine the right choice for their employees and their companies. If you are considering a safe harbor 401(k) and would like more information on the pros and cons, call us at (312) 973-4913 or email mark.olsen@PlanPILOT.com.
About Mark
Mark Olsen is the managing director at PlanPILOT, an independent retirement plan consulting firm headquartered in Chicago. PlanPILOT delivers comprehensive retirement plan advisory services to 401(k) and 403(b) plan sponsors. Drawing on more than two decades of experience, Mark provides institutional retirement plan consulting to 401(k), 403(b), and defined benefit plans. His specialties include plan governance, investment searches, investment monitoring, and plan oversight. Mark is recognized as a leader in the industry and speaks at national conferences, including those organized by Pensions & Investments, Stable Value Investment Association, and CUPA-HR.
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(1) https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview
(2) https://www.paychex.com/articles/employee-benefits/is-a-safe-harbor-401k-right-for-you
(3) https://www.paychex.com/articles/employee-benefits/is-a-safe-harbor-401k-right-for-you
(4) https://www.investopedia.com/terms/q/qualified-automatic-contribution-arrangements-qacas.asp
(5) https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview
(6) https://www.irs.gov/retirement-plans/notice-requirement-for-a-safe-harbor-401k-or-401m-plan