As a business owner, it's crucial to understand the various retirement plan options available to you and your employees. One increasingly popular small business option is the Qualified Automatic Contribution Arrangement (QACA) Safe Harbor Plan. The SECURE Act 2.0 now requires automatic enrollment for new plans. This makes Qualified Automatic Contribution Arrangements (QACAs) one of the lowest-cost Safe Harbor designs. This applies to plans that started after December 29, 2022.

While QACA plans have existed since the Pension Protection Act of 2006, they were not particularly popular. This was because QACA plans require automatic enrollment, often making them more expensive than other options. However, the Secure Act now requires all new plans to use automatic enrollment. This change has made traditional Safe Harbor plans the most expensive option for most new plans.

The Secure Act Changed the game, making a QACA 401(k) the best choice for most if not all companies setting up a new Safe Harbor 401(k). It can do everything a traditional Safe Harbor plan can, but adds valuable options that give employers more flexibility and the potential to lower costs. - Jeffrey Schulte, Head of Retirement Product

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.

What Is a Safe Harbor 401(k) Plan?

Safe Harbor 401(k) plans allow employers to avoid IRS mandated annual nondiscrimination tests. Established under Internal Revenue Code 401(k)(12), Safe Harbor 401(k) Plans from nondiscrimination tests, provided the employer agrees to make a minimum annual contribution - traditionally a 4% match. Employers can also make a 3% nonelective contribution to all employees, regardless of whether make elective deferrals). The “safe” part of the plan is that it protects employers from unknowingly violating nondiscrimination requirements.

Without a Safe Harbor 401(k), employers must perform annual nondiscrimination testing on their plans. This process can take a lot of time and can be complex. Moreover, companies that fail nondiscrimination tests, often need to refund contributions to highly-compensated employees or make additional contributions to non-highly-compensated employees.

What Is a QACA Safe Harbor 401(k) Plan?

QACA Safe Harbor plans are likely the most affordable Safe Harbor option - especially for new plans with high turnover. They offer three key safe harbor provisions that can significantly lower employer contribution costs:

1. A lower total Safe Harbor Match - 3.5% of pay
2. A more gradual matching structure
3. Vesting Schedules - up to 2yr cliff
   

The QACA Match (3.5%)

They offer a lower basic match of at least 3.5% of pay. Employers that want to be more generous have the same flexibility as traditional plans. They can offer a better match as long as employees do not need to make elective contributions over 6% to receive the full match.

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Attractive QACA Matching Tiers

The QACA Safe Harbor matches 100% on the first 1% an employee saves and then 50% on the next 5% they save. With a more gradual minimum matching structure, QACA plans can save employers up to 33% of contribution costs, especially when considering new plans that must enroll eligible employees at a minimum savings rate of 3%.

Traditional Safe Harbor plans match, however is 100% on the first 3% an employee saves and 50% on the next 2% they save. That means an employee only needs to save 5% of their pay to receive the full match. It also means that a defaulted employee will receive a 3% match.

The QACA Safe Harbor matches 100% on the first 1% an employee saves and then 50% on the next 5% they save. Not only is the minimum QACA match capped at 3.5% of pay, employees now must save at least 6% to get the full match. Moreover, the defaulted employee only receives a 2% match (2% = 100% * 1% + 50% *  2%).

"The gentle match tiers of the QACA not only encourages employees to save more to get the full match, but it can also lower the employer cost - especially for plans with high rates of employees that stay at the default." 

-Jeff Schulte, Head of Product at ForUsAll.

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QACA Vesting Schedules

The QACA Safe Harbor vesting schedule can also significantly reduce overall company costs and discourage employer turnover. Employees who leave before completing two years of service will lose their Safe Harbor employer contributions. Forfeited contributions stay in the plan in a forfeiture account. Employers can use funds in this account to offset the match cost in later years - effectively recycling the match.

"Recycling forfeited match dollars not only lowers company expenses, it can concentrate the company contributions in the accounts of the employees that stay with the business the longest - perfect for employers that want to really reward long-tenured employees." - David Ramirez, CFA

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QACA Auto-enrollment requirement:

The main drawback is that QACA plans require employers to automatically enroll employees at a minimum of 3%. They must also automatically increase savings rates by at least 1% each year until employees save 10%.

Employees can choose to opt out of the plan. They can also adjust their savings rates, either lower or higher. Additionally, they can turn off the automatic increases in savings.

However, the higher participation and savings rates from automatic enrollment often lead to more employees getting the full match. This often offset the cost savings from the lower 3.5% QACA match.

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Secure Act 2.0 Makes QACA Safe Harbor The Cheapest Option for New Plans

Under the new Secure Act 2.0, most new plans must use auto-enrollment features. This applies to both traditional and Safe Harbor plans. These features are the same as those for QACA plans. They include a 3% default rate and a 1% auto escalation to 10%.

Let's look at a few examples, to understand why QACA's are a low cost safe harbor option.

QACA vs. Traditional Safe Harbor: Match Tier Example

Let's assume a company has 20 employees, with a $100k average salary.

Traditional: Auto-enrolled employee: $3,000 (EE), Match $3,000 = total $60,000

QACA: Auto-enrolled employee: $3,000 (EE), Match $2,000 = total $40,000

QACA vs. Traditional Safe Harbor: Vesting Example

Now let's assume that 50% of employees leave in their first year, forfeiting half of the company contribution made in year 1. Acme can use these forfeited dollars to subsidize the match in the next plan year. Their match cost in year two is now only $20,000 ($40,000 match - $20,000 forfeited in year 1).

Benefits of a QACA Safe Harbor Plans

QACA Safe Harbor plans offer a number of benefits for both new and existing plans.

• Increased plan participation: QACA safe harbor plans make it easy for employees to save for retirement. They are an automatic retirement account, that can greatly increase employee participation and savings over time.
• Significant Tax Credits: Some employers may qualify for tax credits. These include Start-Up Tax Credits, Automatic Enrollment Tax Credits, and Employer Contribution Tax Credits.
• Attract & Retain Employees: Employers can provide a competitive match to employees on day 1. If employees leave, before completing two years, the employees forfeit their entire match.

Top 3 ways QACA Safe Harbor Plans lower employer costs

• Lower Safe Harbor Match: QACA Safe Harbor plans only require employers to match up to at least 3.5% of pay. Traditional Safe Harbor plans require a minimum 4% match.
• Better Match Structure: The QACA Safe Harbor offers a cost-effective match structure. It reduces costs by 33% for employees who are auto-enrolled at 3% (compared to the traditional Safe Harbor).
• Two-Year Cliff Vesting: QACA Safe Harbor plans allow employers vest the Safe Harbor Match. Any unvested contributions can help pay for plan costs and support matches in future years.

What Are the Drawbacks of QACA Safe Harbor Plans?

Some potential drawbacks of a QACA plan include:

• Possible higher costs: Plans that are not part of auto-enrollment may save money with a regular safe harbor match. This is especially true if they expect low enrollment. With higher employee participation comes higher costs related to matching contributions. Assess these projected costs before implementing a QACA safe harbor plan.
• Potential employee confusion: Employees may forget to opt out of the QACA safe harbor plan before their first contribution. This is where proactive, communication and effective employee education can make a difference.

Which is cheaper QACA or Traditional Safe Harbors?

A QACA Safe Harbor can reduce Safe Harbor Match costs. This is especially true if you expect many people to enroll in the 401(k) plan without auto-enrollment. Additionally, companies with high turnover can often significantly reduce the match cost by leveraging vesting schedules.

The 3.5% QACA Safe Harbor match will cost less than the traditional 4% match for many plans. This is true if 88% or more of employees receive the full match.  

Requirements for QACA Safe Harbor Plans

Automatic Employee Contributions

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.

Employer Contributions

As a business owner, you have to make either a QACA safe harbor match or a QACA nonelective contribution:

• Basic QACA match: Match 100% of the first 1% of deferred compensation and match 50% on the next 5% of deferred compensation. Under this formula, employees saving 6% or more will receive a 3.5% match (3.5% = 1% * 100% + 50% * 5%).
• Enhanced QACA match: Customize your match to give employees more.  For example, you can provide a 2% match on the first 1% and a 50% match on the next 3% (3.5% match in total).  Alternatively, you could match 200% on the first 2% saved (4% match in total).  
• Nonelective QACA contribution: Your company puts in at least 3% of each employee's pay. This happens even if the employee does not contribute to the plan.
• Enhanced QACA nonelective contribution: Employees receive more than 3% of their pay as a company contribution.  

Enhanced QACA Match Requirements: 

An enhanced QACA match, is highly customizable, provided you adhere to these rules:

1. You cannot require employees to save more than 6% to get the full match.
2. Employees must receive the same or more with an enhanced match at each savings level.  
3. Each successive tier must match at the same or lower rate than  prior tiers. For example, you can match 100% on the first 3% and then 50% on the next 2%. However, you cannot match  50% on the first 1% and 100% on the next 4%).

Employee Notice Requirements: 

To operate a 401(k) plan, employers must provide a variety of notices to employees from Participant fee disclosures to summary plan descriptions

QACA vs. EACA: What’s the Difference?

Eligible automatic contribution agreements (EACAs) were created under the Pension Protection Act and were designed to encourage greater adoption of automatic enrollment. Like QACA plans, they require employers to provide notice and automatically enroll employees at 3% or more. However, they also provide two important benefits: an unwind option and an 6 month extension for ADP/ACP excess contributions.

• EACAs offer an “unwind” option. Employees can use this option within the first 90 days of their automatic contribution. They can get back their contributions along with any earnings. They would, however, forfeit any employer contributions.
• Extension for return of excess contributions. A common way employers resolve failed nondiscrimination tests is by returning 401(k) contributions for highly-compensated employees, usually within 2 1/2 months after the end of the plan year. EACA plans receive 6 month extension before the 10% excise tax applies

However, unlike QACA plans, EACAs are not exempt from nondiscrimination testing.

But combining the features of both a QACA and an EACA can be a great way to offer a plan that makes automatic enrollment easy and delightful for your team.

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Choosing the Right Plan for Your Business

A traditional safe harbor 401(k) plan might be a good choice for you. It offers a simple plan with immediate vesting of employer contributions. This option does not include automatic enrollment.

On the other hand, a QACA safe harbor plan might be a better choice. It can help boost employee participation. You should be able to manage the administrative tasks of automatic enrollment. This plan also avoids the need for annual nondiscrimination testing.

ForUsAll is here to answer any questions you have about choosing and managing a plan. We can also manage your plan for you.  

FAQ

Can I reduce or suspend matching contributions for a QACA safe harbor plan?

If you are losing money and meet specific criteria, you may be able to pause your matching contributions. You might also be able to lower them. However, you must uniformly apply any changes 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?

To set up a safe harbor plan with a match, you must allow employees to make contributions for three months each 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.

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