What is a Safe Harbor 401(k) Plan?

There are a few types of 401(k) plans available to plan sponsors: the traditional 401(k), the Roth 401(k), the SIMPLE 401(k), and the Safe Harbor 401(k). Each plan has different benefits and drawbacks, but they all share one common feature: a requirement that the plan sponsor abides by that specific plan’s rules and regulations. Most 401(k) plans face an annual nondiscrimination test defined by the Internal Revenue Service (IRS), which ensures that the plan does not excessively favor highly compensated employees (HCEs) and that their contributions do not exceed the average contributions of non-highly compensated employees (NHCEs) by set limits. Failing to adhere to the IRS’s rules can risk the loss of the 401(k)’s preferable tax status and can be subject to penalties.

For plan sponsors who want to avoid tracking HCEs contributions (and potentially refunding a portion of them at the end of the plan year) or jumping through the necessary administrative hoops for your plan to pass nondiscrimination testing, a Safe Harbor 401(k) may be the answer. Learn more about the features of a Safe Harbor 401(k), its benefits to the plan sponsor and their participants, and how to make this retirement option available.

Features of a Safe Harbor 401(k)

Like a traditional 401(k) plan, a Safe Harbor 401(k) allows employees to contribute annually up to $19,000 in 2019 to a retirement account. However, unlike a traditional 401(k), a safe harbor plan enables the employer to automatically pass the IRS nondiscrimination test as long as they meet the specific contribution, vesting and participant notification mandates.

Safe harbor plans do not require the following compliance tests:

• Actual Deferral Percentage: This test compares the deferral percentage of HCEs and NHCEs. The contributions made by HCEs cannot exceed the NCHEs average contributions by more than 2%.
• Actual Contribution Percentage: This compares the employer matching contributions between HCEs and NHCEs. Contributions made on behalf of HCEs cannot exceed the NCHEs average contributions by more than 2%.
• Top-heavy Plan: This measures the account balances of key employees (owners and officers) against the total assets of the plan, which must not be greater than 60%.

A Safe Harbor 401(k) requires employer contributions that are immediately vested once they’re made. There are three types of mandatory employer contributions from which an employer can select:

• Non-Elective: The employer contributes 3% to all eligible employees regardless if they contribute to the plan or not.
• Basic: A 100% match on an employee’s contribution up to 3% of their annual compensation, plus an additional 50% match on the next 2%.
• Enhanced: The employer must match 100% on the first 4% of an employee’s contribution.

An employer that offers a Safe Harbor 401(k) must provide certain written notices to each eligible employee for the plan year. This annual required notice must contain information about the employee’s rights and obligations under the plan. This includes information about:

• the safe harbor matching method that’s used in the plan;
• how eligible employees can make deferral elections;
• the type and amount of compensation that can be deferred;
• how contributions vest;
• how contributions can be withdrawn; and
• where employees can find other relevant Safe Harbor 401(k) information (whether through a website, an individual in your HR department, or other sources).

This notice must be provided to each eligible employee at least 30 days and no more than 90 days before the plan year begins. This allows employees to review their options well before open enrollment.

Benefits of a Safe Harbor 401(k)

Safe harbor plans can be mutually beneficial for both plan sponsors and plan participants.

For Plan Sponsors

• Exempts the plan from nondiscrimination testing, which reduces plan maintenance and substantial paperwork,
• It allows all eligible employees to max their 401(k) contributions,
• Employer contributions are tax-deductible, and
• Provides an incentive for employees to invest.

For Plan Participants

Plan participants will benefit from the extra savings incentive provided by a match. Many financial advisors recommend that workers set aside at least 10 percent of their annual income towards retirement; for a company offering a generous 4 percent match, an employee can easily reach this savings threshold by putting aside 6 percent of their income. In addition, employer contributions are immediately vested, so employees are not required to work a certain number of years before access to the employer contributions.

For company executives and other HCEs who can often benefit the most from lowering their taxable income through retirement savings, the opportunity to max out one’s 401(k) without worrying about inadvertently over-contributing can be invaluable.

Setting Up a Safe Harbor 401(k) Plan

Plan sponsors who would like to add a safe harbor provision to their current 401(k) are in luck—this process can be as simple as asking the plan administrator to enter an amendment that goes into effect January 1, 2020 (or January 1 of any subsequent year). Because of the 30-day notice requirement, it’s important to make this request in November at the latest, as existing plans can only be converted at the start of a new year. The Safe Harbor 401(k) plan is for organizations of any size and can also be combined with other plans.

As an independent Registered Investment Adviser (RIA), PlanPILOT works as a fiduciary with our clients, controlling the business risks of plan operation and delivering benefits to plan sponsors and participants. If you have more questions about the Safe Harbor 401(k) or want to get started, contact us to get in touch with one of our expert consultants. We encourage you to contact us at (312) 973-4911 or info@planpilot.com so we can help your retirement plan administration team and plan participants achieve better outcomes.

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