The IRS is very specific with their compliance standards. If they see that one employee is contributing to the max while others are not, they begin investigating. A Safe Harbor 401 k is designed to be exempt from this investigation (also called non-discrimination tests).
The idea is to help all employees (usually in a small business or a medium-sized company) by requiring companies to contribute to the 401k plans. It essentially increases the participation rate of employees while the IRS keeps them safe from nondiscrimination testing and any consequences of failure.
What Are 401k Non-Discrimination Tests?
401k non-discrimination tests are annual compliance tests required by law. Two of the tests compare how your normal employees use the company’s 401k, as compared to highly compensated employees (HCEs).
The Actual Contribution Percentage (ACP) test compares the employers’ or business owners’ contributions to HCEs and every other employee. Similarly, the Actual Deferral Percentage (ADP) test measures what percentage of income your HCEs contribute to their 401k plans, compared to every other employee.
The third test is the Top-Heavy test, which the IRS uses to measure the value of 401k account assets of key employees, compared to the total plan assets.
If you fail to comply with all these tests, you may undergo expensive corrections, administrative problems, and may have to refund the 401ks. A Safe Harbor 401k plan helps you avoid all these annual tests.
Setting Up a Safe Harbor 401k
A Safe Harbor 401k plan may be one of the best ways to increase employee retention. To set up a Safe Harbor Plan, you need to incentivize employee participation in the 401k plans. This requirement is in place to encourage more Americans to save up for their retirements.
Most of the rules you need to follow, are there to make sure your eligible employees get the employee benefits they need. Essentially, you’re avoiding non-discrimination tests while helping your employees with their future.
Requirements for a Safe Harbor 401k
There are several requirements for a Safe Harbor 401k. The most important one calls for the employer to make contributions to all the employee 401k accounts. As for the vesting schedule, these contributions should be immediately vested.
There are three different types of contributions. The first two types are matching contributions, in which you should contribute to the 401k plans of employees who defer funds from their income. The third type of contribution needs to be made to employee 401k accounts, even if the employee doesn’t defer any funds to it.
Contributions typically go like this:
- Basic Matching: Followed by most large companies’ plan design, the company (including small business owners) in question initially matches 100% of all the plan participants (employees) 401k contributions and up to 3% of their compensation. For the next 2% of the compensation, the company matches 50%.
- Enhanced Matching: The employer matches at least 100% of all the 401k contributions by the employees, at up to 4% of their compensation. However, the official plan document may state that the compensation percentage cannot exceed 6%.
- Non-Elective Contribution: Regardless of whether or not the employees contribute to their 401k themselves, the company offers a Safe Harbor match of at least 3% of every employee’s compensation.
While these contributions fulfill the Safe Harbor 401k’s main requirement, the plan provider also has secondary requirements. The following pointers need to be followed, if you want a Safe Harbor 401k plan:
- Safe Harbor 401k Contribution Limits: As of 2019, employees can contribute up to $19,000 per year, and participants over the age of 50 can contribute an additional $6,000 per year.
- Employee Notice Requirements: Each of the participants needs to be properly notified (written notice is also required) about their obligations and their rights, according to the plan. The notice needs to be given 30 to 90 days prior to the beginning of the following year’s plan.
- Safe Harbor Deadlines: If you want to start a new plan, the usual deadline is October 1st. However, it’s best to start setting up the plan up months before the deadline because of the notice requirements, and because it takes up to a week to set the plan up. If you want to expand upon an existing Safe Harbor 401k plan, you need to ask your administrator to make a plan amendment, which goes into effect on January 1st. The same notice requirements apply to the latter, so it’s best to start implementing it at least 2 months earlier.
If you want to make any changes to your Safe Harbor 401k plan in the middle of the year, you need to follow some IRS rules. First, you need to provide your employees with a notice that informs them of the changes, 30 to 90 days prior. From there, you need to give the notified employees at least 30 days to decide whether they want to change their contribution/deferral election, or not.
However, there are limits to what you can change in the plan. You will need to be briefed by the company whose Safe Harbor 401k plan you’re using, regarding the changes you can make during the year.
Safe Harbor 401k Review
The Safe Harbor 401k plan works to improve the overall employee experience, while saving you from nondiscrimination tests.
Safe Harbor 401k Pros
The following are some points why this 401k may be a better option for you:
- You automatically pass the nondiscrimination testing.
- It allows your employees to contribute the maximum amount they can to their 401k accounts.
- Encouraging and educating employees to save will give your employee engagement a boost. It will also increase the participation rate, which can improve employee retention.
- You don’t have to monitor HCEs and regular employees, and their contribution amounts.
- The contribution match is tax-deductible.
While Safe Harbor 401k plans are mainly used to pass nondiscrimination tests, they also work well to help employees with their retirement savings, even when they aren’t as knowledgeable on the matter.
Safe Harbor 401k Cons
The following are some reasons why a Safe Harbor 401k may be just another plan:
- The regulations are very strict and the commitment lasts an entire year. If you want to make amendments to the plan, you need to follow a comprehensive set of rules.
- Some providers charge a termination fee if you plan on terminating your account.
- If your employee salaries are high, the plan can end up being expensive.
- Failure to comply with even one rule can lead to administrative hassle, costly corrections, and lots of refunds.
While the plan offers a lot of convenience for you and your employees, it can be expensive and may entail unnecessary costs and hassle if you fail to comply with the requirements.
Do These Plans Always Pass Testing?
There may be times when this plan becomes subject to Top-Heavy Testing. The following are some conditions under which you may be subject to testing:
- If you make a discretionary profit-sharing contribution.
- If you make a discretionary match that’s not exempt from ACP testing.
- 401k deferrals have shorter eligibility requirements than Safe Harbor contributions.
- If the participants make Non-Roth after-tax contributions.
If your Safe Harbor 401k fails the top-heavy test, all of your employer contributions count towards completing the 3% minimum contribution requirement.
Safe Harbor 401k vs Student Loan Benefits
While Safe Harbor 401k plans have proven to be extremely helpful, 49% of millennials still prefer student loan benefits over any 401k contributions. Working on a modern-day solution, the following acts were passed recently.
Retirement Parity for Student Loans Act
The 2018 bill was enforced so that employers can make matching contributions to the student loan payments of their employees. The contributions are made through the employee’s 401k plan and are deferred as salary reduction contributions to the retirement plans.
Employer Participation & Repayment Act
The Employer Participation in Repayment Act of 2019 will let employers make contributions of up to $5,250 to their employees’ student loans. These contributions will be completely tax-free and will be able to be made on both the principal and interest amounts on all qualified educational loans.
FutureFuel.io is one of the companies leading the way to enable employers to contribute towards student loan repayments seamlessly. The company even works with Salesforce and Transamerica employees. FutureFuel.io provides a platform for employees to manage all their student debt in one dashboard. Employees will also get real-time notifications of employer contributions.
Is a Safe Harbor 401k a Better Option for You?
If you’ve had trouble passing 401k testing, the Safe Harbor 401k plan may be your best option. In addition, it helps if you have low participation from NHCEs and non-key employees, and if you plan to match all your employee contributions anyway.
This is why the plan works for mostly small to medium-sized businesses. However, it may not be the best option if those conditions don’t apply to you, or if you don’t have to worry about any of them. All in all, make sure you compare your options and understand them properly before making a final decision.