Failure to Make Safe Harbor Contribution: A Common Mistake in 401(k) Plans
HR and financial managers must ensure their company's retirement plans meet regulatory standards. Many opt for a safe harbor 401(k) because of its tax advantages and talent attraction capabilities. However, these plans come with strict requirements. Failure to make safe harbor contributions may result in penalties and legal repercussions for small businesses.
If your company has missed these contributions, promptly addressing the oversight is crucial. This guide will walk you through safe harbor 401(k) requirements and offer strategies to maintain compliance and prevent future failures.
What Is a Safe Harbor Contribution?
A safe harbor 401(k) plan is a particular type of 401(k) that requires employers to contribute to their employees’ retirement accounts. These contributions must meet specific requirements outlined by the IRS, including a set percentage of salaries or matching contributions up to a certain amount. By adhering to these rules, employers can avoid annual compliance testing while providing their workers with an attractive and valuable benefit.
How to Address a Failure to Make Safe Harbor Contributions
When employers miss safe harbor contributions, immediate corrective action is vital as this is considered a “failure to follow plan terms” under IRS guidelines. The IRS offers two programs for fixing 401(k) mistakes: the Self-Correction Program (SCP) and the Voluntary Correction Program (VCP).
Self-Correction Program (SCP)
The SCP allows employers to rectify specific plan operation errors, such as a failure to make safe harbor contributions, without IRS intervention or fees. To meet eligibility requirements, companies must have procedures in place that usually prevent such errors, indicating the mistake was unusual.
Employers must also follow the criteria for significant and insignificant errors. Insignificant error corrections can occur at any time. However, corrections for significant errors must be completed within a reasonable time by a set deadline (for example, by December 31 of the discovery year) before the end of the third plan year. Failure to meet this deadline disqualifies the employer from SCP and requires the employer to participate in VCP.
Voluntary Correction Program (VCP)
Through the VCP, employers can correct plan operation mistakes, such as missed safe harbor contributions, with IRS oversight. The program is suited for situations where SCP criteria do not apply or when direct IRS approval is preferred.
To participate in VCP, employers must submit a detailed correction plan to the IRS using model documents and forms. The submission must outline the error, the proposed correction, and steps to prevent future mistakes. Additionally, employers must pay a fee based on the plan's size and complexity. Once approved, the IRS will issue a compliance statement confirming the plan's qualification.
Can You Suspend or Reduce Safe Harbor Contributions?
Companies facing financial challenges, business model shifts, or operational changes might wonder if they can stop or adjust safe harbor contributions. Generally, provisions for safe harbor plans should be set up before the plan year kicks off and last the entire year.
However, the IRS allows amendments mid-year in certain circumstances, such as if the company is operating at a loss or if the initial safe harbor notice included a suspension provision.
It's important to know that mid-year changes to safe harbor 401(k) plans are possible but are subject to strict IRS guidelines to maintain fairness and clarity. According to IRS Notice 2016-16, employers must:
- Send a supplemental notice to employees at least 30 days before the change, outlining the suspension and explaining their rights to modify their contribution elections
- Allow employees a reasonable window to adjust their election amounts before halting employer contributions
- Update the plan document to mirror the changes before their implementation
- Fulfill any contributions promised up to the amendment's effective date
The SECURE Act of 2019 removed supplemental notice requirements for specific changes for plan years beginning after December 31, 2019. Employers can now switch to a safe harbor 401(k) plan with nonelective contributions up to 30 days before the plan year's end without issuing notices. Additionally, plans offering a nonelective contribution increase to 4% (from the standard 3%) can amend this change any time before the last day of the following plan year.
What Are the Consequences for Suspending Safe Harbor Contributions?
If an employer suspends safe harbor contributions, the plan must undergo specific nondiscrimination tests to ensure the changes benefit all employees, not just highly compensated ones. These tests — ADP (Actual Deferral Percentage) and ACP (Actual Contribution Percentage) — compare contributions between highly paid and non-highly paid employees. If the test results don't meet IRS standards, the employer must distribute refunds to certain participants or make additional contributions for others.
Additionally, suspending safe harbor contributions may jeopardize the plan's qualified status, which has significant tax implications for employers and employees. If the plan loses its qualified status, contributions made by the employer could be considered taxable income to employees, and any earnings on those contributions may also be subject to taxation.
Can You Reinstate Suspended Safe Harbor Contributions?
Once safe harbor matching contributions stop, they cannot be restarted within the same year, meaning the plan loses its safe harbor status for the remainder. This rule prevents confusion, as employees might have already adjusted their contributions based on the suspension notice.
However, the SECURE Act allows more flexibility for non-elective contributions: employers can introduce a 3% non-elective contribution up until 30 days before the year's end or a 4% contribution by the end of the next plan year. This option does not apply to matching contributions but offers a way to maintain some employer contributions within the same fiscal period.
Best Practices for Avoiding Safe Harbor Contribution Errors
The best way to address safe harbor contribution failures is to avoid them altogether. Here are some best practices to prevent errors and ensure compliance:
Perform annual plan reviews
Understanding and adhering to the safe harbor 401(k) plan document is essential for compliance and the plan's qualified status. Conduct an annual review of all plan operations, including contributions, distributions, and participant data accuracy. Use tools like the IRS 401(k) Plan Checklist to ensure safe harbor contributions meet IRS guidelines. This proactive approach maintains the plan’s integrity and aligns with fiduciary duties.
Review eligibility requirements and contribution formulae
Regular audits of eligibility criteria and contribution formulae are vital to avoid errors. Confirming eligibility can prevent misdirected contributions, and accurately applying contribution formulae avoids compliance pitfalls. Understanding the plan's compensation definition and contribution timing is essential to prevent discrepancies.
Communicate with payroll administrators
Clear communication with the payroll department is essential to timely and accurate safe harbor contributions. The payroll administrator is responsible for deducting and depositing employee contributions, so notifying them promptly of any changes to contribution formulas or eligibility criteria is essential. Maintaining consistency in deposit timing and providing training for new staff are also important.
Stay Compliant — Automatically
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ForUsAll transforms 401(k) management, making compliance straightforward and efficient. Interested in streamlining your plan's compliance? Explore ForUsAll's Safe Harbor 401(k) solutions, or get started today.
