Safe Harbor 401(k) Plans

If you’re operating a small to medium-sized business, success largely depends on who you bring in to help you manage and operate different aspects of your business. You will separate yourself from your competitors by recruiting and keeping great employees. 

Beyond competitive compensation, what you provide as a benefits package will go a long way in your ability to attract and retain the best and the brightest. 

401(k) Plans 

One of the most important and demanded employer-sponsored benefit is a retirement plan. And while there are several types of plans for employers to choose from, the 401(k) is the most common plan that employers implement, largely because employees and employers both enjoy the many investment options available and the ability to customize that other types of retirement plans don’t have. 

There are several types of 401(k) plans available to employers, with different rules applying  to each:

• Traditional 401(k) plans. A traditional 401(k) plan allows eligible employees to make pre-tax elective deferrals through payroll deductions. In addition, in a traditional 401(k) plan, employers have the option of making contributions on behalf of all participants, making matching contributions based on employees’ elective deferrals, or both.
• Safe harbor 401(k) plans. A safe harbor 401(k) plan is similar to a traditional 401(k) plan, but, among other things, it 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. 
• SIMPLE 401(k) plans. The SIMPLE 401(k) plan was created so that small businesses could have an effective, cost-efficient way to offer retirement benefits to their employees. A SIMPLE 401(k) plan is not subject to the annual nondiscrimination tests that apply to traditional 401(k) plans.

What is a 401(k) Safe Harbor Plan?

In short, a safe harbor 401(k) plan isn’t subject to the annual nondiscrimination tests that apply to traditional 401(k) plans. Specifically, the rules of section 416 of the IRS Code don’t apply to Safe harbor 401(k) plans that do not provide any additional contributions in a year. 

Benefits to Employers of Safe Harbor 401(k) Plans

The benefits to the employees participating in a Safe Harbor 401(k) plan are much the same as a traditional 401(k) plan, though with an important difference of having immediate vesting of the employer contributions. Additionally: 

• They allow business owners and other highly-compensated employees (HCEs) to contribute the maximum annual deferral amount into their accounts.
• They allow plans to bypass top-heavy rules and discrimination tests for salary deferrals and employer contributions, as long as they meet the safe harbor provisions.
• They limit the effects commonly felt from IRS top-heavy and non-discrimination testing.
• They may help reduce business taxes and help employees build a larger nest egg all at the same time.

Types of Safe Harbor Contributions

1. Safe harbor basic match: This formula matches employee contributions dollar-for-dollar up to 3% of the employee’s compensation and 50 cents on the dollar for the next 2% of compensation. So, if an employee contributes at least 5% of their salary to their 401(k), they receive the maximum employer contribution of 4%. Safe harbor basic match is considered to be the least expensive safe harbor contribution option.
2. Safe harbor enhanced match: The safe harbor enhanced match is a more generous matching formula compared to the basic match. Employers match 100% of employee contributions up to a certain percentage, between a minimum of 4% or a maximum of 6%, of the employee’s compensation. This contribution type also might provide the employee with an added incentive to contribute more to their salary. 
3. Safe harbor non-elective contribution: Safe harbor non-elective contribution is a type of employer contribution to 401(k) plans that provides a flat percentage of each employee's compensation, regardless of whether the employee contributes to their 401(k). With this plan, the company must contribute a minimum of 3% of each eligible employee’s compensation. 

Safe Harbor 401(k) Eligibility Rules

All employees that are eligible to contribute to a 401(k) plan are also eligible for the Safe Harbor match or nonelective contribution. Plan sponsors are required to offer the Safe Harbor 401(k) to all employees who are at least 21 years of age and have worked at least one year with at least 1000 hours of service. 

To get the benefits of safe harbor, employers should understand that plans must also meet several criteria just to qualify, including required employer contributions, mid-year amendment restrictions, and potential notice requirements.

Additionally, due to the Secure Act, new plans now must have automatic enrollment. Safe harbor plans that have Qualified Automatic Contribution Arrangement (QACA), have different matching provisions than the standard safe harbor plans.

QACA Provisions

• Regular match: The company matches 100% of all employee 401k contributions, up to 1% of their compensation, plus 50% match of the next 5% of their compensation.
• Enhanced match: 200% of all employee 401k contributions, up to 2% of their compensation
• Non-elective: This stays unchanged at the current 3%

Another important change with the QACA safe harbor plan vs. the standard safe harbor is that a 2-year vesting schedule is allowed rather than being immediately eligible.

Not sure if safe harbor is right for your company? 

A Safe Harbor 401(k) is a great benefits tool for employers and their employees, but it’s not for everyone or every company. It's always a good idea to consult with a financial advisor to best understand the fee structure, plan options, compensation types and eligibility requirements for this type of plan and others to consider.