Why do 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.
What are the alternatives to Safe Harbor plans?
One 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.
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.
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.
How do 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.
What are the 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.