Know Your Safe Harbor Plan Design Options, Part 1
Unbeknownst to many employers, there are multiple 401(k) Safe Harbor Plan design options and benefits to each. Choosing the right design can help a company achieve important organization objectives.
In general, a “safe harbor” is a provision of a law or regulation that may be followed to achieve compliance with that law or regulation. Non-discrimination rules require that both highly compensated and non-highly compensated employees receive a comparable benefit from a company’s 401(k) plan, and various tests determine if the rules are met. Failing the tests can result in adverse consequences for some plan participants, such as the return of a portion of their deferrals (contributions) to highly compensated employees when the Actual Deferral Percentage or ADP test fails. Operating as a Safe Harbor plan, employers make contributions that allow the plan to automatically “pass” the tests, and thus all employees may fully benefit from the tax advantages the 401(k) plan offers.
Safe Harbor plans also automatically pass the Actual Contribution Percentage or ACP test and can avoid the need for corrective contributions if the plan is “top heavy,” which occurs when more than 60 percent of the plan’s assets are held by key employees (certain owners and officers of the company).
The Safe Harbor Non-Elective Contribution
- Employers make a contribution to eligible plan participants that is equal to 3% of their salary.
- This contribution is advantageous when an employer also makes a profit-sharing contribution, particularly when the plan is operating as a “new comparability” or “cross-tested” plan, which allows higher profit-sharing contributions to be made to certain employees to incentivize or reward performance. Varying profit-sharing contributions often require minimum “gateway” contributions to all participants. The 3% non-elective contribution may be applied to meet the “gateway” requirement.
- If the non-elective contribution is the only employer contribution being made, it may be more expensive to the company than a higher “matching” safe harbor contribution because it must be made to all eligible participants, even if they are not deferring to the plan.
- A variation that can be included in a plan’s design requires the 3% contribution only to non-highly compensated employees, making the contribution optional to those who are highly compensated.
- The non-elective contribution may be made throughout the plan year or after the plan year is concluded but before the organization’s tax return is filed.
The Safe Harbor Match
- Two match alternatives exist – the basic and the enhanced match. Both are made only when a participant defers to the 401(k) plan. The basic match provides a 100% match on the first 3% of deferred compensation plus a 50% match on deferrals between 3% and 5%. The enhanced match normally provides a 100% match on the first 4% of deferred compensation. Both options result in a maximum employer contribution equal to 4% of compensation.
- This contribution is advantageous because it encourages employees to contribute toward their retirement in order to receive the employer’s match.
- Even though the company may contribute more to each participant with a match instead of a non-elective contribution (4% vs. 3%), the overall cost may be less because the company makes contributions only to deferring participants.
- The matching contribution may be made throughout the plan year or after the plan year is concluded but before the organization’s tax return is filed. When the contribution is made throughout the plan year, it may be “trued up” if allowed by the company’s plan documents. A true up could occur when a participant deferred at an inconsistent rate but, in total, deferred the maximum 4% or 5% of compensation.
Both the safe harbor non-elective contribution and the safe harbor match are fully vested, or “owned” by participants once they are made. There is a third 401(k) Safe Harbor Contribution Plan option that many employers find advantageous because employees must be participants for as long as two years in order to be fully vested in employer contributions. A second part to this Blog will describe this option, which also encourages greater participation and savings rates.
The safe harbor decision is made annually before the beginning of the 401(k) plan year. It’s a good idea to conduct plan testing to determine if it’s possible to operate without a safe harbor. Creative contribution strategies exist for non-Safe Harbor Plans to encourage greater participation and savings rates. If the decision is to continue to operate with a safe harbor, participants must receive a notice 30 days – but no more than 90 days – before the plan year begins. Employers may always look to knowledgeable advisors and expert Third Party Administrators for assistance in evaluating safe harbor and non-safe harbor options.
Written by Laurie C. Wieder, PPC®, Vice President, Alliant Wealth Advisors, Qualified Plans Division
This blog is written to help make the lives of plan sponsors easier in the process of meeting legal requirements under ERISA for their defined contribution plans. Please understand that reading this blog should not alone take the place of a one-on-one consultation regarding the needs of your specific plan, and hence cannot be a guarantee against fiduciary breaches.