As a business owner, it's crucial to understand the various retirement plan options available to you and your employees. One such option is the qualified automatic contribution arrangement (QACA) safe harbor plan. With lower Safe Harbor Match expenses, automatic enrollment and optional vesting schedule, this type of 401(k) plan offers unique features that can benefit both employers and employees.
This guide will discuss the difference between QACA and traditional safe harbor 401(k) plans. We'll also explore the requirements, benefits, and potential drawbacks of QACA safe harbor plans.
A safe harbor plan is a 401(k) plan that requires employer contributions; a traditional 401(k) plan doesn’t require employers to contribute. The “safe” part of the plan is that it protects employers from unknowingly violating nondiscrimination requirements.
With a traditional 401(k), employers must subject plans to annual nondiscrimination testing, which can be a time-consuming and complex process. Safe harbor plans are exempt from most annual nondiscrimination testing.
A QACA safe harbor plan is a specific type of safe harbor plan that automatically enrolls employees, but gives them the ability to opt out. This type of plan originated with the Pension Protection Act of 2006, which aimed to increase worker participation in retirement plans.
In addition to negating the need for most nondiscrimination testing, the benefits of safe harbor plans include:
Some potential drawbacks of a QACA plan include:
A QACA Safe Harbor may lower Safe Harbor Match costs, especially if you expect high 401(k) enrollment or have high employee turnover.
First, if you expect more than 88% of employees to get the full traditional match, then the lower 3.5% match requirement (compared to 4% for traditional safe harbor match) is likely cheaper.
Second, any unvested QACA contributions can be used to subsidize company contributions in future years. With a 2-year cliff vesting schedule, any employee that leaves the company before completing 2-years of service will forfeite their company contributions. These forfeited contributions can be “recycled” and lower QACA contribution expenses in later years.
The initial automatic employee contribution rate must be at least 3%. If the initial contribution rate is less than 6%, it must increase by at least 1% annually until it reaches 6%. Employers can set an automatic escalation cap as high as 15% per year.
As a business owner, you have to make either a QACA safe harbor match or a QACA nonelective contribution:
Eligible automatic contribution agreements (EACAs) and QACAs both automatically enroll employees, but they differ in two important ways:
A traditional safe harbor 401(k) plan may be suitable if you want a straightforward plan with immediate vesting of employer contributions and don't want an automatic enrollment feature. Conversely, a QACA safe harbor plan could be a better fit if you want to encourage higher employee participation, can handle the administrative work of implementing automatic enrollment, and don’t want to go through annual nondiscrimination testing.
By understanding the pros and cons of 401(k) plan options, you can make an informed decision that serves the best interests of your business and your employees. Always consult with your plan advisor, attorney, or accountant to ensure you choose the most suitable plan for your business.
ForUsAll is happy to answer any questions you have about choosing and managing a plan — and we can even administer your plan for you.
Can I reduce or suspend matching contributions for a QACA safe harbor plan?
If you’re operating at a financial loss and meet several criteria, you may be able to pause or reduce your matching contributions. However, any changes must be uniformly applied to all plan participants.
What are the benefits of matching employee contributions?
Matching employee contributions is an additional cost for your business, but it also reduces your taxable business income. And offering matching contributions could help you recruit and retain top talent.
Is a QACA safe harbor plan only for large businesses?
No — a QACA plan is suitable for small and medium businesses, too.
Do I have to wait until the start of the year to set up a QACA safe harbor plan?
The rule for establishing a safe harbor plan with a match is that you give employees the ability to make three months of contributions in a calendar year. So you can set up a new plan at any time, as long as it’s live by October 1.
Are there any tax credits for setting up a 401(k) plan?
Employers with 100 or fewer employees may be eligible for a tax credit of up to $5,000 for setting up a plan.
David Ramirez, CFA, is a recognized 401(k) expert with over 20 years of experience in 401(k), ERISA, cash balance plans, and ESOPs. A UC Berkeley graduate, he played a pivotal role at Financial Engines, a 401(k) advisory firm founded by Nobel Laureate William Sharpe, Ph.D., where he was a portfolio manager who helped manage over $50B in 401(k) assets. His clients included some of the largest Fortune 500 companies and state governments.
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