Safe harbor 401(k) plans are the most popular type of 401(k) used by small businesses today. They automatically pass annual ADP/ACP and top heavy tests and allow business owners to maximize contributions to the plan. To achieve safe harbor status, owners are required to make a contribution on behalf of participating employees. For many employers, that trade-off is well worth the cost. Here’s why.
When 401(k) testing fails, it’s usually business owners that bear the brunt of the consequences. And small businesses tend to fail more because business owners generally have a larger percentage of plan assets. They often receive the largest 401(k) refunds when the ADP/ACP test fails and they must generally make a 3% contribution to non-owners when the top heavy test fails.
Given these consequences, it’s little wonder why business owners find safe harbor 401(k) plans attractive. They allow business owners to maximize their 401(k) contributions without the risk of refunds, while generally costing the same as a top heavy 401(k) plan.
However, safe harbor 401(k) plans aren’t for everybody. They are subject to special contribution and vesting requirements that can make them more expensive for small businesses than a traditional 401(k) plan.
We get a lot of questions from business owners trying to weigh the benefits of a safe harbor 401(k) plan vs. any additional cost. Below is a FAQ with answers to the most common questions we receive. If you are a small business owner, you can use this FAQ to help decide whether a safe harbor 401(k) plan is right for your company
Safe harbor 401(k) plans require an employer to make either an eligible matching or nonelective contribution to participants:
These contributions can be limited to just non-Highly-Compensated Employees (HCEs). They must be 100% immediately vested.
A QACA is a newer type of safe harbor 401(k) plan. They include an automatic enrollment feature that automatically enrolls any eligible employee that fails to make an affirmative enrollment election in the plan at a specified deferral rate. These plans include the following special rules:
Yes. Regardless of a 401(k) plan’s safe harbor status, profit sharing contributions must satisfy 401(a)(4) testing. “Pro-rata” or “permitted disparity” allocations generally pass this test automatically, while “new comparability” allocations must pass 401(a)(4)’s general test.
Yes. A discretionary matching contribution is exempt from the ACP test just like a safe harbor match when two conditions are satisfied:
For example, a discretionary 50% match on the first 6% of deferred compensation (3% total) would be exempt from the ACP test
No. Safe harbor 401(k) plans become subject to top heavy testing for plan years in which one or more of the following conditions apply:
When a safe harbor 401(k) plan fails the top heavy test, any employer contributions made to the plan count towards satisfying the 3% top heavy minimum contribution.
Safe harbor 401(k) plans can be a great choice for small businesses that have trouble passing 401(k) testing. However, they are not for everybody – they can be more expensive than traditional 401(k) plans. You should weigh the pros and cons of theses plans before choosing one for your company.