Safe Harbor 401(k) Plans: Contributions, Matches, & More

If you’re considering offering a 401(k) for your employees or already do but are looking to ease administration and maximize your contributions as an owner so you can better save for retirement, you may want to consider a safe harbor plan.

While there are different types of safe harbor plans, they’re generally designed to ensure that contributions from rank-and-file employees are proportional to those made by highly compensated employees (HCEs) so the plan doesn’t unfairly favor certain workers.

Complete Payroll Solutions is a retirement plan administrator for thousands of companies throughout the Northeast. We understand the factors companies should consider when designing a 401(k) plan for their employees, and when a safe harbor plan may be a good option.

To help you understand whether a safe harbor plan could work for your business, in this article, we’ll discuss:

• What is a safe harbor plan
• Safe harbor plan requirements
• The benefits of safe harbor plans
• How to choose between a traditional 401(k) vs safe harbor plan

After reading this article, you’ll know whether or not a safe harbor plan is an ideal 401(k) plan design for your company.

What is a safe harbor 401(k)?

A safe harbor plan is a type of 401(k) that is primarily intended to ensure your plan doesn’t discriminate in favor of key or highly compensated employees. With all types of safe harbor plans, you’ll make annual contributions on behalf of your employees. 

Type of safe harbor 401(k)s

There are four different types of safe harbor 401(k) plan designs:

1. Non-elective: With this type of safe harbor plan, you’ll make a year-end contribution, giving everyone who is eligible a contribution equal to 3% of their pay. That’s the case even if they’re not contributing to the plan.
2. Basic match: A basic safe harbor 401(k) plan has a required employer match. You’ll need to match 100% of the first 3% of an employee’s contribution, then 50% on the next 2%. With this plan, unlike the non-election option, only those employees who contribute to the plan receive the match.
3. Enhanced match: In this safe harbor plan arrangement, you match 100% of the first 4% of an employee’s contribution. Like the basic match, only employees who are contributing to the plan are eligible for the match.
4. Auto-enrollment: Another way to design a safe harbor 401(k) is to include an auto-enrollment feature. This plan type, known as a qualified automatic contribution arrangement (QACA) must have a minimum automatic contribution percentage of 3% for the first year of an employee’s participation, which increases to 4% in the second, 5% in the third, and 6% in the fourth year. (The maximum automatic percentage can’t be more than 15%.) You would have to match 100% of the first 1% of an employee’s contribution plus 50% on the next 5% for a maximum of 3.5% on the first 6%. Alternatively, you can make a non-elective contribution of at least 3% of compensation to all eligible non-highly compensated employees.

With the first three types of safe harbor plans, the employee fully vests in your match contributions immediately. With the auto-enrollment option, the employee must be fully vested by the time they’ve completed no more than two years of service.

The Benefits of Safe Harbor Plans

There are two primary reasons companies will choose to offer a safe harbor 401(k).

Elimination of Nondiscrimination Tests

Each year you offer a traditional 401(k), you’re required to conduct non-discrimination testing to make sure your plan isn’t discriminating against lower-income workers in favor of owners or highly compensated employees. For 2021, HCEs are those who own more than 5% of the business or make more than $130,000.

To make this determination, there are a series of annual tests that your plan must undergo. Generally, these are performed by a third-party administrator (TPA). The series of annual tests include: 

• Actual Deferral Percentage (ADP) Test: This test compares the average deferrals of non-highly compensated employees with the average for HCEs.
• Actual Contribution Percentage (ACP) Test: This is like the Actual Deferral Percentage Test but includes the employer match contributions and after-tax contributions employees make.
• Top Heavy Test: This test takes the sum of all key employee balances compared to the total plan balance. Key employees are officers who make over $185,000, employees who own 5% of the company or family members of one, or those who own more than 1% and make over $150,000. If key employees own more than 60% of the value of plan assets, the plan is top-heavy.

These tests are technical and can be challenging to understand. However, the bigger issue is what happens if you fail one.

If your company fails the ADP or ACP test, you’ll get a required refund of your excess contributions, which can impact both your 401(k) savings goals and your taxable income for the year. And if your plan is top heavy, you’ll need to make a 3% contribution to non-owners, which can get expensive.

With a safe harbor 401 (k), you eliminate these tests. This can be a big financial relief for many companies.

Greater Contribution Limits for HCEs

If the primary reason you’re offering a 401(k) is to benefit you as the business owner or key employees, then a safe harbor option can offer important advantages.

Specifically, with a safe harbor plan, you and your HCEs will be able to maximize your 401(k) retirement contributions without having to worry about your plan failing annual discrimination tests. As a result, it can be a better long-term savings vehicle.

The trade-off for these benefits is that you have to make mandatory contributions to your employees’ 401(k) accounts.

Safe Harbor Plan Requirements

Just like traditional 401(k) plans, there are rules you’ll need to follow in order to keep your safe harbor plan in compliance with ERISA, a law enacted to protect individuals in health and retirement plans.

To start, the first year you offer a safe harbor plan, the deadline for establishing the plan is October 1 for a calendar-year plan. That’s because employees need time to make salary deferral contributions to their accounts.

In addition, you have to follow participant disclosure requirements unless you’re offering a nonelective-based safe harbor plan since the SECURE Act made notices exempt in those situations.

To comply, you’ll have to distribute to plan participants an annual safe harbor notice. This notice informs employees of their rights and obligations under the plan and must include:

• whether the employer will make matching or nonelective contributions
• other contributions under the terms of the plan
• the plan to which the safe harbor contributions are made, if more than one plan
• the type and amount of compensation that may be deferred under the plan
• how to make salary deferral elections
• the specific time periods under the plan to make salary deferral elections
• withdrawal and vesting provisions for plan contributions
• how to easily obtain additional information about the plan (including a copy of the summary plan description)

The notice must be distributed in a timely manner. That means it should be sent within a reasonable period before the beginning of each plan year or:

• At least 30 days (and no more than 90 days) before the beginning of each plan year
• In the year an employee becomes eligible, generally no earlier than 90 days before the employee becomes eligible and no later than the eligibility date

If you fail to provide a safe harbor notice, that constitutes an operational failure for your plan. In that case, you’d have different options to address this situation depending on the effect on participants. For example, if an employee wasn’t able to make contributions because of the missing notice, then you may have to make a corrective contribution.

Should I choose a safe harbor 401(k) plan design?

There’s no one-size-fits-all 401(k) plan design for businesses. Rather, it’s important to understand whether a safe harbor or traditional 401(k) option makes the most sense for your company’s unique needs.

A safe harbor 401(k) can be a good choice if:

• You and/or your HCEs view the 401(k) as a primary retirement vehicle and want to maximize contributions
• Your plan recently failed compliance testing or you don’t want to worry about it every year
• Participation in your 401(k) is low so your match contributions won’t be too expensive

A safe harbor 401(k) may not be the right fit if:

• Because of your employees’ salaries, the contribution requirements make it too costly
• You have a lot of turnover and don’t want employees to immediately vest in the 100% of your match (you may be able to work around this with eligibility requirements)
• You’re satisfied with the amount you’re able to save in a traditional 401(k) and view the 401(k) as a plan for your employees’ benefit and not your own

If you’re interested in setting up a new safe harbor 401(k) or converting your traditional 401(k) into a safe harbor plan, it’s critical that you understand what your expected contributions may be based on your payroll. This will provide you with the knowledge to decide if a safe harbor plan is something you can afford. To learn what you can expect to pay to offer a 401(k), read our next article.