Safe Harbor 401(k) Plans – “Tis the Season!”
If you are an employer who currently sponsors a retirement plan or is considering one, or an advisor who provides tax or financial guidance to employers and business owners, you need to be aware that September is the crucial month for installing a safe harbor 401(k) plan or adding a safe harbor option to an existing profit sharing plan.
What is a Safe Harbor 401(k) Plan?
A safe harbor plan is a traditional 401(k) plan that includes “safe harbor” provisions. As with any type of 401(k) plan, employees may make pre-tax deferral contributions and/or post-tax Roth deferral contributions. A safe harbor plan requires that certain employer contributions be made on behalf of the employees. These required employer contributions exempt the plan from many of the complex rules that apply to 401(k) plans.
Why Would an Employer Want A
Safe Harbor 401(k) Plan?
All 401(k) plans are required to perform special nondiscrimination tests with respect to the amount of the deferral contributions and employer match contributions made on behalf of the highly compensated and non-highly compensated employees. These special tests are known as the ADP test for deferral contributions and the ACP test for match contributions.
For many employers, especially smaller employers whose employee population consists of an owner(s) who is a Highly Compensated Employee and the rest of the employees who are non-highly Compensated Employees, it is difficult to satisfy the special nondiscrimination tests for deferral contributions and match contributions.
The owners typically defer the maximum amount, $18,000 in 2016 with a $6,000 catch up if the owner is 50, while the other employees defer smaller amounts or nothing at all. Employers utilize safe harbor options to avoid having to perform the special ADP & ACP tests. If the ADP test is failed, to correct the failure, the employer must either fund a special QNEC contribution for the non-highly compensated employees or the plan must refund the excess contributions and earnings to the highly compensated employees. The refund of excess contributions triggers taxable income to the highly compensated employee.
Types of Safe Harbor Plans
There are different types of safe harbor contribution options which the employer can elect.
One is a matching contribution alternative made to only those participants who make deferral contributions and the other is a 3% nonelective contribution alternative (similar to a profit sharing contribution) made to all eligible participants even if the employee does not make deferral contributions to the plan.
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- Basic Safe Harbor Match: 100% of the first 3% of compensation deferred plus 50% of the deferrals made up to 5% of compensation. This option can be used to satisfy the ADP & ACP tests.
- Enhanced Safe Harbor Match: An employer can design a matching formula that exceeds the basic safe harbor match formula. As long as the match contributions are limited to a 6% deferral rate and the enhanced match is fully vested, then the enhanced match does not need to be tested.
3% Nonelective Contribution: The employer must contribute 3% of each eligible participant’s compensation regardless of whether or not the employee makes deferral contributions. This option can only be used to satisfy the ADP test. Any match contributions other than a safe harbor match must be tested under the ACP test.
- Note: There is also a contingent nonelective safe harbor option which gives the employer the flexibility to decide whether or not to fund the nonelective safe harbor contribution for any year. If the safe harbor contribution is not funded, the plan must perform the nondiscrimination test for the deferral contributions (ADP).
Special Requirements for Safe Harbor Plans
- The employer must make the safe harbor contribution each year.
- All safe harbor contributions are 100% vested at all times.
- Safe Harbor Notices must also be given to every participant each year.
Design Considerations for
Safe Harbor Plans
Top Heavy Plans
All safe harbor contribution options can be used to satisfy minimum top heavy contributions in any year.
However, if an additional profit sharing contribution is made and the plan uses the match safe harbor alternative, additional top heavy contributions must be made for those employees who are not receiving a match safe harbor contribution or a match safe harbor contribution that is less than the top heavy minimum contribution.
New Comparability
Profit Sharing Allocations
New comparability plans, sometimes known as “rate group” plans, require a minimum gateway contribution for non-highly compensated employees in addition to requiring the plan’s allocation formula to satisfy special nondiscrimination tests under IRC 401(a)(4).
Only the 3% nonelective safe harbor option can be used to satisfy the minimum gateway requirement. This gives the nonelective safe harbor option an advantage over the match safe harbor option since this one nonelective contribution source can be used to satisfy the ADP test, top heavy contributions and the minimum gateway funding requirement making it a less expensive design choice.
Timing Deadlines
A new safe harbor option must be in place for the last three months of the plan year. For calendar year plans, this means October 1st.
A new safe harbor plan can have an initial short plan year; however, the plan must be in existence for at least three months.
Employers and their advisors should not delay making changes to add a safe harbor option or plan past these deadlines if the safe harbor is desired for this year. If the deadline is missed for adding the safe harbor option in 2016, the safe harbor option will be effective for 2017.
Jo-Ann Massanova
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