Safe harbor plans exist for employers to avoid two tests the IRS runs every year, known as nondiscrimination tests — but safe harbor plans are costly.
Given such a high cost of offering an employer match, it’s important to remember they are NOT always necessary and to consider alternative ways of passing the nondiscrimination tests before Safe Harbor.
Before we discuss them, it’s worth revisiting the tests the IRS uses to determine whether a company’s 401(k) plan didn’t discriminate in favor of highly compensated employees (the highest earners in the company).
Back in the day, when the IRS set up the rules for 401(k) plans, it wanted to make sure that the program helped everyone save money for retirement. The government didn’t want a situation where bosses were able to shelter lots of money from taxes while ordinary employees received no benefits at all.
This policy worked great for almost everyone, unless you were a small business owner.
Bottom-line: if you’re like a lot of our customers, and debating whether or not you should go with a safe harbor plan, it’s good to know what the tests are. Read these two articles if you need a quick refresher on top heavy testing and/or the ACP and ADP tests.
Not everyone can afford safe harbor plans.
The tough part about a safe harbor 401(k) plan, in which an employer is required to make a contribution for all employees, is that it works, but it’s expensive – although it’s cheaper than returning retirement contributions, says Jerry Geisel of Crain’s Benefit Outlook.
For one of our customers, an apparel manufacturer, the firm’s owners were advised to provide a safe harbor 401(k) plan.
Their financial adviser looked at their relatively low-wage employee base, and believed the company was at risk of failing the nondiscrimination tests.
Since safe harbor wasn’t affordable, they almost decided not to offer a 401(k) plan.
**How much would it cost you to make safe harbor contributions?**
# employees x % participating x average salary x 4% safe harbor contribution = $$
Consider a 50 employee business.
If your employees earn an average of $40,000 and 60 percent of the employees participate in the 401(k) plan, a 4% safe harbor 401(k) employer contribution will be $48,000 a year.
The cost of safe harbor 401(k) contributions can mean not offering a 401(k) at all.
Because of this a lot of business owners decide not to offer a retirement plan at all, rather than be locked into something that is not affordable.
It’s not that the owners are greedy jerks. The IRS policies don’t seem to take into account the ever-changing financial state that small businesses are in as they establish themselves.
And yet, everyone still needs to save for retirement.
Employees want to work for a company that offers a retirement plan. Owners need to save for their own retirements.
The alternative: Design a plan that works for your workers.
The good news? There are ways other than a safe harbor 401(k) plan to meet the IRS nondiscrimination requirements.
Remember the apparel manufacturer we worked with to set up a non-safe harbor 401(k) plan?
As of November 1, 2015, 74 percent of eligible employees at the company were participating in the 401(k) plan. And over 70 percent of those who participate have signed on to automatically increase their savings rates by 1 percent each year.
Your alternative is to get a 401(k) plan that is very good at getting people to use the plan, and helps people save at high rates. It’s cheaper for you, and good for your employees.
The keys to getting high participation and savings rates means getting a 401(k) plan built with lots of automation that’s accessible on mobile devices. Again, this will help give you what you need to skip safe harbor contributions and still pass nondiscrimination testing. And it will give your employees a benefit that works for their financial futures.
You know you’re looking at a next-generation 401(k) plan when you see:
- Features designed to promote high participation and savings rates
- Automatic compliance with regulatory requirements
- Workplace communication on mobile and web that helps employees without imposing high costs on them or your business.
ForUsAll’s small business 401(k) programs give more Americans a better way to save for retirement without costing the small business owner (and employees) an arm and a leg. Follow ForUsAll on Twitter to keep up with the latest company news and tips.
If you’re wondering if a safe harbor alternative could work out for you, we offer free custom analysis to help you make the right choice for you and your business.