A safe harbor 401k plan allows business owners to pass annual IRS nondiscrimination testing automatically. These plans also offer mandatory employer contributions that are immediately vested. They can be structured as an essential matching or an enhanced matching plan. Although a safe harbor 401k will cost your company a little regarding its contribution to employee accounts, it will save you from the headache of complying with the IRS’s nondiscrimination testing each year.
Nondiscrimination Testing
If you’re looking for a way to attract and retain talented employees, consider adding a Safe Harbor 401(k). But what is a Safe Harbor 401(k) plan? This plan design option is an attractive alternative to traditional retirement plans because it avoids the hassle of compliance testing. However, it’s essential to understand the cost associated with this type of plan.
A safe harbor 401(k) is an employer-sponsored retirement plan that doesn’t require annual nondiscrimination testing. Employers must make mandatory contributions to eligible employees’ accounts, which are vested immediately. There are several different ways to structure these contributions, each with its own rules. For example, some companies may match only the first 3% of an employee’s deferrals. In contrast, others may match all non-key employees’ contributions, regardless of whether they’re made elective or matching.
This plan design option can be a good fit for small businesses, family-owned companies, or those with high percentages of highly compensated employees. It also works well for employers who need help passing the nondiscrimination tests of their traditional 401(k) plans. Nondiscrimination testing is required for most traditional 401(k)s, but it can be time-consuming and expensive. It involves checking that the average contribution for highly compensated employees is, at most, the average for all employees by more than 2%.
Taxes
A Safe Harbor 401k is an employer-sponsored retirement plan that avoids annual IRS nondiscrimination testing. This plan is a popular option for small businesses because it can help them attract and retain qualified employees while saving on administrative fees. However, it’s important to consider the tax implications of using this type of plan.
The IRS wants to make sure that a 401(k) doesn’t favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs). The agency requires companies to perform compliance tests called ADP/ACP and top-heavy tests to do this. These tests compare the amount of deferrals made by HCEs to those of NHCEs, ensuring there isn’t too much discrepancy between the two groups. In addition, the employer must match employee contributions up to 3% of compensation or contribute to a profit-sharing plan for a certain percentage of employees’ total wages. This plan type can be a good fit for small business owners who want to offer a matching contribution but need deep pockets to support it with a traditional 401(k) or other plan types.
Vesting Schedules
In addition to the mandatory contribution and participant disclosure requirements, Safe Harbor plans must also include a vesting schedule for employer contributions. This type of schedule is usually based on years of service and must be 100% vested at termination of employment or upon partial or full plan termination.
A Safe Harbor 401k can have either a 3% non-elective contribution or a 4% match for non-key employees. The 3% non-elective contribution is the same as that of the traditional 401k but does not trigger a top-heavy test. In addition, a Safe Harbor plan allows highly compensated employees (HCEs) to max out their annual contributions without fear of an excess contribution refund.
HCEs can be vested in all employer matching and profit-sharing contributions, and there are no limits on those contributions, unlike traditional 401ks. You can add a 3-year cliff or 6-year graded vesting schedule for employee after-tax contributions, but you cannot apply allocation conditions to them.
However, you can attach a vesting schedule to your 401k plan’s safe harbor non-elective contribution. This allows you to incentivize long-term employment and increase matching contributions to key employees. You can also use a vesting schedule for the 401k plan’s matching and non-safe harbor contributions.
Contributions
A Safe Harbor 401(k) is an alternative to the traditional 401(k). It provides an employer contribution of up to 4% of employees’ wages. The match is vested immediately and is tax-deductible for the business. It also allows highly compensated employees (HCEs) to maximize their salary deferrals and helps them achieve financial wellness. However, the plan is only for some. It’s a good choice for small businesses and HCEs who want to avoid the hassle of annual nondiscrimination testing.
The IRS has established required compliance tests to ensure that 401(k) plans do not favor HCEs over non-HCEs. The Safe Harbor plan bypasses these requirements by contributing to all eligible employees. Depending on the size of your company, you can choose between a basic match and an enhanced match. Enhanced matches allow employers to be more generous than the basic 4% match. While a Safe Harbor 401(k) is a great solution for many small businesses, weighing the pros and cons of this type of retirement plan with your advisor is crucial. It may only be right for some companies, especially if it has many HCEs or low participation rates among non-HCEs.
