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The Ultimate Guide to Safe Harbor 401(k) Plans

Eric Droblyen

on March 30th, 2022

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Safe harbor 401(k) plans are subject to employer contribution and participant disclosure requirements that don’t apply to traditional (non-safe harbor) 401(k) plans. In exchange, a safe harbor plan can automatically pass the ADP/ACP test and satisfy the minimum contribution requirement when the top heavy test fails. Because many small 401(k) plans (under 100 participants) have a hard time passing the ADP/ACP and top heavy tests, safe harbor plans are popular with small businesses.

We receive a lot of questions from business owners about safe harbor 401(k) plans. In this guide, we’ll answer the most common.

If you have safe harbor questions, we hope you'll find our guide helpful.

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What is a Safe Harbor 401(k) Plan?

Safe harbor 401(k) plans can automatically pass the ADP/ACP nondiscrimination test and satisfy the top heavy minimum contribution requirement by meeting certain employer contribution and participant disclosure requirements. They are most popular with businesses who cannot pass the ADP/ACP and top heavy tests with a traditional 401(k) plan.

Below is a summary of the major differences between safe harbor and traditional 401(k) plans:

Feature

Traditional 401(k) Plan

Safe Harbor 401(k) Plan

Eligibility 

The eligibility requirements for all plan contributions can be different.

Safe harbor contributions can't be subject to a stricter eligibility requirement than elective deferrals to automatically satisfy top heavy minimum standards.

Employer Contributions

Not required. Matching and profit sharing contributions may be subject to allocation conditions (e.g., 1,000 hours, employment on the last day of the plan year).

Required. One of the following contributions must be made to participants:

  • Nonelective Contribution –3% (or more) of compensation, regardless of elective deferrals.
  • Basic Match – 100% of the first 3 percent of compensation, plus 50% on the next 2 percent (4% of compensation total).
  • Enhanced Match – Must be at least as much as the basic match at each tier of the match formula. 100% match on the first 4% of compensation is common.
  • QACA(1) Match – 100% of the first 1 percent of compensation, plus 50% on the next 5 percent of compensation (3.5% of compensation total).

Highly-Compensated Employees (HCEs) can be excluded from any of these contributions, but allocation conditions (e.g., 1,000 hours of service, “last day rule”) cannot apply.

Additional matching and profit sharing contributions permitted. The additional match can be exempt from the ACP test when certain conditions are met.

Vesting Requirement

Employer contributions can be subject to a 3-year cliff or 6-year graded vesting schedule

Safe harbor contributions are generally subject to 100% immediate vesting. Safe harbor contributions made to a QACA can be subject to a 2-year cliff schedule.

Participant Disclosure

Not applicable

All match-based plans must distribute a safe harbor notice to participants prior to initial plan eligibility and then 30-90 days before the start of each new plan year.

Nonelective-based plans are exempt unless 1) the employer wants a discretionary match to meet ACP safe harbor requirements, or 2) the plan includes an Eligible Automatic Contribution Arrangement (EACA).


What is a Qualified Automatic Contribution Arrangement (QACA)?

A Qualified Automatic Contribution Arrangement (QACA) is a type of automatic enrollment arrangement that incorporates a safe harbor match or nonelective contribution. The automatic enrollment feature can make a QACA more complicated to administer than a classic safe harbor 401(k) plan, but they can cost less due to more liberal employer contribution and vesting requirements.

Below is a summary of the major differences between classic and QACA safe harbor plans:

Feature

Classic Safe Harbor Plan

QACA Safe Harbor Plan

Automatic Enrollment

Optional. 

Required. The default deferral rate must start at no less than 3% and increase at least 1% annually to no less than 6%. The default rate cannot exceed 10% for the first year of plan participation and 15% after that.

Employer Contributions

Employers must make one of the following safe harbor contributions to participants:

• Basic match – 100% of elective deferrals up to 3% of compensation, plus 50% on the next 2% (4% of compensation total).
• Enhanced match – Must be at least as much as the basic match at each tier of the match formula. 100% match on the first 4% of compensation is common.
• Nonelective contribution – 3% (or more) of compensation, regardless of elective deferrals.

Highly-Compensated Employees (HCEs) can be excluded from any of these contributions, but allocation conditions (e.g., 1,000 hours of service, “last day rule”) cannot apply.

Additional matching and profit sharing contributions permitted. The additional match can be exempt from the ACP test when certain conditions are met.

Employers must make one of the following safe harbor contributions to participants:

• Basic match – 100% of elective deferrals up to 1% of compensation, 1, plus 50% on the next 5% of compensation (3.5% of compensation total).
• Enhanced match – Must be at least as much as the basic match at each tier of the match formula.
• Nonelective contribution – 3% (or more) of compensation, regardless of elective deferrals.

Highly-Compensated Employees (HCEs) can be excluded from any of these contributions, but allocation conditions (e.g., 1,000 hours of service, “last day rule”) cannot apply.

Additional matching and profit sharing contributions permitted. The additional match can be exempt from the ACP test when certain conditions are met.

Vesting Requirement

Safe harbor contributions are subject to 100% immediate vesting.


A 3-year cliff or 6-year graded vesting schedule can be applied to additional employer contributions.

Safe harbor contributions may be subject to a 2-year cliff schedule.


A 3-year cliff or 6-year graded vesting schedule can be applied to additional employer contributions.

Participant Disclosure

All match-based plans must distribute a safe harbor notice to participants prior to initial plan eligibility and then 30-90 days before the start of each new plan year.


Nonelective-based plans are exempt unless 1) the employer wants a discretionary match to meet ACP safe harbor requirements, or 2) the plan includes an Eligible Automatic Contribution Arrangement (EACA).

Safe harbor notice must also include certain automatic enrollment and QDIA information.


How to Choose Between a Safe Harbor and Traditional 401(k) Plan?

Reasons to choose a safe harbor 401(k) plan:

  • The plan will be top heavy. Because a top heavy 401(k) plan must generally make a 3% minimum contribution to non-key employees, the 3% nonelective contribution will cost about the same. The 4% match might even cost less than the top heavy minimum contribution if participants defer at low rates.
  • The plan will fail the ADP and/or ACP test. A safe harbor plan allows HCEs to maximize their annual contributions without fear of refund due to failed testing.
  • Business owners want to offer plan with a generous employer contribution.

Reasons to choose a traditional 401(k) plan:

  • The plan will have no trouble passing the ADP/ACP and top heavy tests.
  • Business owners want to discourage employee turnover by adding allocation conditions (e.g., 1,000 hours, employment on last day of plan year) and/or vesting schedule to matching contributions.
  • Business owners want to use a “stretch” match formula (e.g., 25% of elective deferrals up to 10% of compensation) to incentivize employees to make bigger elective deferrals. 

What Are the Consequences When the ADP/ACP and Top Heavy Tests Fail?

When a small business 401(k) plan fails the ADP/ACP or top heavy test, it's business owners who usually bear the brunt of the consequences.

  • ADP/ACP Test– The Actual Deferral Percentage (ADP) tests pre-tax and Roth elective deferrals - not including catch-ups - for nondiscrimination, while the Actual Contribution Percentage (ACP) tests matching and voluntary (after-tax) contributions.  The ADP/ACP test fails when the average contribution rate of Highly-Compensated Employees (HCEs) exceeds the non-HCE average by more than the allowable amount.

When an ADP/ACP test fails, the most common correction method is refunding the contributions made to HCEs in the amount necessary to pass the applicable test.

For 2022, an HCE is defined as an individual that meets one of the following criteria: 

    • They own more than 5% of the employer (either directly or by family attribution) at any time during 2021 or 2022, or
    • They received more than $130,000 in compensation from the employer during 2021. Alternatively, a plan may also limit this group to the top 20% of employees, ranked by compensation.
  • Top Heavy Test – A 401(k) plan is considered top heavy for a plan year when the account balances of “key employees” exceed 60% of total plan assets as of the last day of the prior plan year.

When the top heavy test fails, a top heavy minimum contribution must be allocated to non-key employees. This contribution must equal the lesser of:

    • 3%,
    • The highest contribution rate allocated to any key employee – including elective deferrals.

A “key employee” is defined as any employee (including former or deceased employees), who at any time during the plan year was:

    • An officer making over $185,000, or
    • A 5% owner of the business (a 5% owner is someone who owns more than 5% of the business), or
    • An employee owning more than 1% of the business and making over $150,000 for the plan year.

 


What % of Small Business 401(k)s Fail the ADP/ACP and Top Heavy Tests?

Recently, we studied 3,217 small business 401(k) plans to learn the percentage that failed the ADP/ACP and top heavy tests. We found 26.47% of traditional plans failed the ADP test, while 45.41% of all plans were top heavy. I think it’s safe to assume the percentage of safe harbor plans that would fail the ADP test if their safe harbor provisions were removed would be greater than the 26.47% found for traditional plans. 

 


Plan Type

 


Plans

Studied

Failure Rate

ADP

ACP

Top Heavy

402(g)

415(c)

Traditional 401(k) - no automatic enrollment

598

25.59%

4.68%

12.04%

3.18%

0.50%

Traditional 401(k) - automatic enrollment

101

31.68%

2.97%

2.97%

0.99%

0.00%

Safe Harbor 401(k) - no automatic enrollment

2,252

N/A

N/A

56.88%

2.58%

0.49%

Safe Harbor 401(k) - automatic enrollment

266

N/A

N/A

39.47%

3.38%

0.38%

All Plans

3,217

26.47%*

3.74%*

45.41%

2.70%

0.47%

*Excluding safe harbor plans

 


Under What Conditions Can a Discretionary Match Meet the ACP Safe Harbor?

When a discretionary match is made in addition to a safe harbor contribution, it can be exempt from the ACP test when the following conditions are met:

  • The match formula cannot be based on more than 6% of deferred compensation.
  • The match cannot exceed 4% of deferred compensation in total.
  • The match was disclosed in a safe harbor notice.

For example, a discretionary 50% match on the first 6% of deferred compensation (3% total) would be exempt from the ACP test, while 25% match on the first 10% of deferred compensation (2.5% total) would not.

A discretionary match made to a safe harbor plan can be subject to a vesting schedule – up to a 3-year cliff or 6-year graded schedule.

 


When Will a Safe Harbor Plan Not Automatically Meet Top Heavy Standards?

A safe harbor 401(k) plan won’t automatically satisfy the top heavy minimum contribution requirement for plan years in which one or more of the following events occur:

However, all employer contributions made during the year will count towards satisfying the 3% top-heavy minimum contribution.

 


What are the Participant Disclosure Requirements for a Safe Harbor 401(k) Plan?

The SECURE Act changed the participant notice requirement for safe harbor 401(k) plans. While all match-based plans must distribute a notice, nonelective-based plans are exempt unless 1) the employer wants a discretionary match to meet ACP safe harbor requirements for the year, or 2) the plan includes an Eligible Automatic Contribution Arrangement (EACA).

When applicable, a safe harbor notice must be distributed to plan participants within a reasonable period before the start of each plan year. In general, “reasonable” means:

  • 30-90 days before the start of each plan year.
  • For new participants, generally no earlier than 90 days before their plan entry date and no later than that date.

What’s the Deadline for Adopting a New Safe Harbor 401(k) Plan?

In general, the first year of a new safe harbor 401(k) plan must be at least 3 months long – to give all plan participants the opportunity to make elective deferrals. That means the deadline for employers to adopt a new calendar-based plan is October 1.


What’s the Deadline for Amending a Traditional 401(k) into a Safe Harbor Plan?

A formal plan amendment must be adopted to convert a traditional 401(k) into a safe harbor plan. The deadline for adopting this amendment will depend upon the type of safe harbor contribution to be made.

  • Safe harbor match amendment deadline is the last day of year preceding the plan year in which the plan will be safe harbor.
    • However, match-based safe harbor plans must distribute a safe harbor notice to participants sooner - 30-90 days before the start of the plan year. The SECURE Act eliminated the safe harbor notice requirement for nonelective-based plans.
  • Safe harbor nonelective The SECURE Act made the amendment deadline much more flexible for these plans. It’s based on the nonelective contribution formula:
    • Less than 4% - up to 30 days before the close of the plan year in which the plan will be safe harbor.
    • 4% or greater - The last day of the plan year following the plan year in which the plan will be safe harbor (i.e., the deadline for distributing ADP/ACP corrective refunds).

How Soon Can a New Safe Harbor Plan be Adopted When a SIMPLE IRA is in Place?

All SIMPLE IRAs operate on a calendar year basis. Replacing a SIMPLE IRA with a 401(k) plan (regardless of the plan’s safe harbor status) takes some planning due to the following IRS rules:

  • A SIMPLE IRA must be the sole retirement plan in effect for the calendar year.
  • SIMPLE IRAs can’t be terminated mid-year.
  • For a SIMPLE IRA to be terminated at year-end, participants must be notified at least 60 days in advance (November 2).

Due to these rules, the soonest you can implement a new safe harbor 401(k) plan is January 1 following the year in which you terminate a SIMPLE IRA.

Example: On November 25, 2021, ABC Company decides to terminate its SIMPLE IRA as soon as possible. The soonest the SIMPLE IRA can be terminated is January 1, 2023. ABC must notify its employees about the termination before November 2, 2022.


Are There Special Rules for Amending a Safe Harbor Plan Mid-Year?

Yes. To amend a safe harbor 401(k) plan mid-year, an employer must meet the following conditions:

  • If the amendment will affect the content of the safe harbor notice provided before the start of the plan year, the employer must:
    • Distribute a new notice to eligible employees 30-90 days before the effective date of the amendment.
    • Give eligible employees a reasonable opportunity to change their deferral election before the amendment’s effective date. A 30-day election period is deemed reasonable.
  • The amendment cannot be a prohibited mid-year change listed in Notice 2016-16.

Can Safe Harbor Contributions be Reduced or Suspended Mid-Year?

Yes. A safe harbor match or nonelective contributions (as applicable) can be reduced or suspended mid-year when all of the following conditions are met:

  • Either of the following conditions applies:
    • The plan sponsor is operating at an economic loss.
    • The safe harbor notice provided before the start of the plan year states you may reduce or suspend contributions mid-year.
  • A supplemental notice is distributed to eligible employees at least 30 days before the effective date of the reduction or suspension.
  • Eligible employees have a reasonable opportunity to change their deferral election before the reduction or suspension occurs.
  • The 401(k) plan is ADP/ACP tested for the full plan year using the current year testing method.

What Tax Credits Apply to Safe Harbor 401(k) Plans?

The SECURE Act permits an eligible small business (under 100 employees) to claim a tax credit for adopting a new 401(k) plan (regardless of the plan’s safe harbor status) and/or a new automatic enrollment feature.

  • Qualified startup costs - Before the SECURE Act, a small business could claim a tax credit equal to 50% of their “qualified startup costs,” up to a $500 limit. Now, the limit is the greater of (1) $500 or (2) the lesser of (a) $250 multiplied by the number of non-Highly Compensated Employees (non-HCEs) eligible for plan participation or (b) $5,000. This credit is available for up to three years.
  • Automatic enrollment - Small businesses can earn an additional $500 tax credit by adding an automatic enrollment feature to a new or existing 401(k) plan. The credit is available for each of the first three years the feature is effective.

When combined, these credits can total up to $5,500 per year ($16,500 for 3 years).


Know Your Options!

Safe harbor and traditional 401(k) plans have trade-offs. For small business owners to make the best choice, they must know how to weigh the pros and cons of these plans. Our guide can help.

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