What is a Safe Harbor 401(k)?

Your plan could benefit from an extra compliance boost via safe harbor.

The Safe Harbor 401(k) plan is a way for employers to bypass large compliance hurdles such as the IRS non-discrimination tests. It enables employers to essentially exempt themselves from red tape by making specific contributions to employees' retirement savings accounts. You can think of it as giving eligible employees an immediate raise in exchange for fewer administrative headaches. The problem is that safe harbor contributions are expensive. Use the calculator below to estimate exactly how much.

What are the Safe Harbor 401(k) contribution requirements?

There are two different ways an employer can make safe harbor contributions: matching or nonelective contributions.

Basic matching contribution
Dollar for dollar on the first 3% of what an employee saves, and $0.50 on the next 2% the employee saves. It effectively works out to a 4% match. Sometimes this is called an elective option, as the employee must decide (or elect!) to save into the plan to receive the match. In other words, the employer doesn’t contribute anything to employees who elect not to participate, and employees who contribute >3% are eligible to receive an additional contribution (as much as 4% in total) from their employer.
Nonelective contribution
Contribute 3% into each employee’s 401(k) plan. That’s 3% of the specific employee’s gross pay as long as the employee is eligible for the 401(k) plan, regardless of whether they’re putting in money themselves. With this type of employer contribution, the employee does not have to opt to save anything into the plan; the employer commits to make a 3% salary contribution to all employees who are eligible to participate in the plan.

What are the vesting schedules for employer contributions?

In other words, how much of the company’s contributions does the employee get to keep? All of it. Safe Harbor contributions must always be 100% vested (unlike company match or profit-sharing contributions (although you could elect to have these 100% vested as well). So, even if the employee leaves in the middle of the plan year, you must give them their employer contribution for the time they were eligible for the Safe Harbor 401(k) plan. Because a well designed profit sharing plan can allow you to make allocations several months into the next year, this means that employees who were terminated the previous year could receive the allocation. You should consult with a retirement plan consultant, and make sure you understand your plan design before making profit sharing decisions.

When do you pay the contributions?

Depending on your cash flow needs, you can fund the Safe Harbor contributions each pay-period, at the end of each quarter, or even annually. You simply need to make sure all Safe Harbor contributions are made according to IRS Regulations. A good 401(k) provider will calculate your Safe Harbor contributions proactively and review the timing of those contributions so you can have the option to choose when to make payments into the 401(k) plan.

Learn more about Safe Harbor 401(k) Plans

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    Safe Harbor Handbook

    An introductory eBook all about safe harbor plans, how they work, and if they’re right for you.

    Get the eBook
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    IRS Test Basics

    Dive into the IRS top heavy test and identify the key employees in your company.

    Read the article
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    Boost Enrollment

    Learn how high participation and savings rates can help you pass IRS nondiscrimination tests.

    Learn More

Safe Harbor 401(k) Notifications

When your business elects to offer a Safe Harbor plan you also are legally required to carefully calculate employee eligibility to contribute to the retirement plan - and provide notifications of eligibility and of the plan’s Safe Harbor status. Sending out Safe Harbor notices can be an administrative burden if your current 401(k) advisor doesn’t make sure this work is taken care of for you. The dates for the notices and implementation are set by the IRS and may change. Not all 401(k) advisors and administrators will do a good job making sure you’re kept in the loop! In general, the law considers notices timely if the employer gives them:

  • To employees at least 30 days (and no more than 90 days) before the beginning of each plan year
  • In the year an employee becomes eligible, generally no earlier than 90 days before the employee becomes eligible and no later than the eligibility date.

Why Safe Harbor Plans Exist

Safe harbor plans exist for employers to avoid annual IRS nondiscrimination tests. The IRS uses these tests to determine whether a company’s 401(k) plan discriminates in favor of highly compensated employees (the highest earners in the company). 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 trying to keep costs low.

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How the IRS Nondiscrimination Tests Work

The IRS nondiscrimination tests (the ADP and ACP) compare the contributions or savings rates of one group of employees to the other. Plans must run the tests to determine whether employees across the company, regardless of how much they make, are saving at appropriate relative rates or total dollar amounts. What the IRS doesn't want to see are highly compensated employees (HCEs) 401(k) contributions making up more than 60% of the total plan assets.

Challenges of Safe Harbor Plans

The tough part about a safe harbor plan is it’s expensive. Because of this, a lot of business owners decide not to offer a retirement plan at all, rather than be locked into contributions that they can't afford. Unfortunately, IRS policies don’t seem to take into account the ever-changing financial state that small, lean businesses are in as they establish themselves. Curious if your organization can afford to contribute on employees' behalf and avoid annual IRS Nondiscrimination Tests?

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Safe Harbor Alternative

Your alternative is to design a plan that works better for your employees. There are ways other than a safe harbor 401(k) plan to meet the IRS nondiscrimination requirements. 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 key to getting high participation and savings rates is 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 avoid safe harbor contributions and still pass nondiscrimination testing. And it will give your employees a benefit that works for their financial futures. Talk to us today to find out how to pass compliance tests without the high cost of a Safe Harbor Plan!

Safe Harbor Glossary

ForUsAll offers a more complete 401(k) term glossary on our resources page, but the following terms may be helpful if you are considering a safe harbor 401(k), or if you are already administering one for your small business.

  • Highly Compensated Employee (HCE)
    An individual who:
    owned or owns a large stake of the company - more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received

    Or an individual who:
    for the preceding year, received compensation from the business of more than $120,000, and if the employer so chooses, was in the top 20% of employees when ranked by compensation.
  • Non-highly Compensated Employee (NHCE)
    All other employees that don’t meet the IRS definition of a highly compensated employee.
  • Actual Deferral Percentage (ADP)
    An annual test in a 401(k) plan that compares the average salary deferrals of highly compensated employees to that of non-highly compensated employees (NHCE). The government generally likes it when the plan benefits everyone. First, each employee’s deferral percentage must be calculated - the deferral percentage is the percentage of eligible compensation that has been saved to the 401(k) plan. Then, take all of the Highly Compensated Employees and average their deferral percentage. Next average the deferral percentages of all of the Non-Highly Compensated Employees. To pass the test, the Actual Deferral Percentage of the HCE group (the average of that group) may not exceed the ADP for the NHCE group by 1.25 percent or the lesser of 2 percentage points and two times the NHCE ADP.
  • Actual Contribution Percentage (ACP)
    An annual test in a 401(k) plan that compares the average salary deferrals of highly compensated employees to that of non-highly compensated employees (NHCE). Plan sponsors must test traditional 401(k) plans each year to ensure that the contributions made by and for rank-and-file employees (Non-Highly Compensated Employees) are proportional to contributions made for owners and managers (Highly Compensated Employees). As the NHCEs save more for retirement, the rules allow HCEs to defer more. These nondiscrimination tests for 401(k) plans are called the Actual Deferral Percentage and Actual Contribution Percentage tests. The ACP test is met if the ACP for the eligible HCEs doesn't exceed the greater of:

    - 125% of the ACP for the group of NHCEs, or the lesser of:

    - 200% of the ACP for the group of NHCEs, or
    - the ACP for the NHCEs plus 2%.

  • Top-Heavy Plan
    The top-heavy rules generally ensure that the lower paid employees receive a minimum benefit if the plan is top-heavy. A plan is top-heavy when, as of the last day of the prior plan year, the total value of the plan accounts of key employees is more than 60% of the total value of the plan assets.
  • Key Employee
    To determine if your plan is top-heavy, you must first identify key employees - any employee (including former or deceased employees AND spouses, lineal ascendants, and lineal descendents of Key Employees), who at any time during the plan year was one or more of the following:

    - An officer making over $170,000 (2015 and 2016)
    - A 5% owner of the business (a 5% owner is someone who owns more than 5% of the business)
    - An employee owning more than 1% of the business and making over $150,000 for the plan year. Note that this may include employees who have unexercised, vested options - so companies that use option plans as part of their compensation packages should take care.

  • Qualified Automatic Contribution Arrangement (QACA)
    A QACA is a type of Safe Harbor plan that uses automatic enrollment with automatic savings escalation, a feature that automatically increases an employee’s savings rate by 1% each year. Under the QACA plan, the savings rate escalation must stop when the employee reaches a 10% savings rate and the employee has the option to change or opt out of the plan at any time.
  • Employer Discretionary Match
    The employer can make matching contributions for an employee who contributes elective deferrals (for example, 50 cents for each dollar deferred). Employer matches can be on a vesting period where the full match amount might be paid out over six years, which can aid in retaining key talent.
  • Safe Harbor 401(k) Contributions Tax year
    The timing of the contribution may impact the tax year, for which the expense cay be deducted.