Safe harbor 401(k) plans are the most popular type of 401(k) sponsored by small businesses today. They can help business owners maximize their annual contributions by automatically passing certain annual tests. The trade-off is that a safe harbor 401(k) plan must make mandatory employer contributions and must provide notices to employees.
We offer a general outline of safe harbor 401(k) plans here. The information below provides a more in-depth look at certain aspects to safe harbor 401(k) plans. You can use this information to help decide whether a safe harbor 401(k) plan is right for your business.
Can Non-Elective Contributions in Addition to Safe Harbor Contributions be Made to a Safe Harbor 401(k) Plan?
Yes. Non-elective contributions, also known as profit-sharing, made to a safe harbor 401(k) plan are treated the same as if made to a conventional 401(k) plan. Therefore, you are able to apply allocation conditions to the non-elective contributions and the non-elective contributions must satisfy the 401(a)(4) nondiscrimination test. Non-elective contributions in addition to safe harbor contributions may also be subject to vesting.
To illustrate, your 401(k) plan uses the safe harbor non-elective contribution option and you also want to provide an additional non-elective contribution. The first 3% of employee’s compensation contributed to the plan as a non-elective contribution will be used to satisfy the safe harbor requirement. Any additional compensation contributed as a non-elective contribution may be subject to allocation conditions, such as being employed on the last day of the plan year, and may be subject to vesting, such as a 3-year cliff schedule.
Can Match in Addition to Safe Harbor Contributions be Made to a Safe Harbor 401(k) Plan?
Yes, match in addition to either match or non-elective safe harbor contributions can be contributed to the plan. The additional match can be either a fixed formula or discretionary. You may apply allocation conditions to the additional match or have it be subject to vesting. Certain annual testing, including the ACP test, must be satisfied for the additional match.
However, the additional match may be exempt from ACP testing if it meets the following conditions:
- The match cannot be based on more than 6% of deferred compensation.
- A discretionary match cannot exceed 4% of compensation.
- The match rate cannot increase as elective deferral rate increases.
- The match cannot be subject to allocation conditions.
To illustrate, your 401(k) plan uses the safe harbor non-elective contribution and provides for a discretionary match. Your business had a good financial year in 2023 and you would like to give back to employees who were contributing to the plan. You decide to provide a match of 100% of elective deferrals up to 4% of deferred compensation. Any employee making elective deferrals in 2023 is eligible for this match. Your safe harbor 401(k) plan would be exempt from ACP testing for the 2023 plan year.
On the other hand, if the match was 50% of elective deferrals up to 8% of deferred compensation, your safe harbor 401(k) plan would be subject to ACP testing for the 2023 plan year. Even though the maximum match is the same – equal to 4% of compensation – the match cannot be based on more than 6% of deferred compensation. This additional match may still be contributed without impacting the plan’s safe harbor status, but the additional match will be subject to ACP testing.
One final note, match in addition to safe harbor contributions may be subject to vesting.
Is a Safe Harbor 401(k) Plan Always Exempt from Top-Heavy Testing?
No. One of the benefits of being a safe harbor 401(k) plan is that you are generally exempt from top-heavy testing. However, if you select certain plan design features, your plan may not be exempt. In other words, you, as the employer, control whether your safe harbor 401(k) plan is always exempt from top-heavy testing. The following plan design features result in your safe harbor 401(k) plan being subject to top-heavy testing:
- Eligibility requirements for safe harbor contributions are longer than for elective deferrals.
- A non-elective (a/k/a profit-sharing) contribution (including forfeiture reallocations) is made during the year.
- A match that is not exempt from the ACP test is made during the year.
- Employee after-tax (non-Roth) contributions are made during the year.
If your plan is subject to top-heavy testing and it is determined to be top-heavy, all employer contributions made during the plan year, including safe harbor contributions, will count towards satisfying the top-heavy minimum contribution.
To illustrate, your 401(k) plan uses the safe harbor match contribution and allows for a non-elective contribution. In 2023, you decide to provide a non-elective contribution to any eligible employee who met the allocation conditions (i.e., worked more than 1,000 hours and was employed on the last day of the year). Due to the non-elective contribution in 2023, your safe harbor 401(k) plan is subject to top-heavy testing. If it is determined that your plan was top-heavy for 2023, then the safe harbor match contributions along with the non-elective contributions both count in satisfying the top-heavy minimum contribution requirement.
Are Notices Required for Safe Harbor 401(k) Plans Using Non-Elective Contributions?
Maybe. A safe harbor non-elective 401(k) plan is generally exempt from the participant notice requirement. A notice is still required if:
- You provide a match in addition to the safe harbor contributions that is exempt from the ACP test.
- You have an automatic enrollment feature (required for a QACA safe harbor plan).
- You want the ability to reduce or suspend safe harbor contributions mid-year without operating at an economic loss.
Is it Possible to Reduce or Suspend Safe Harbor Contributions Mid-Year?
Yes. You can reduce or suspend either match or non-elective safe harbor contributions mid-year when all of the following conditions are met:
- The business is either:
- Operating at an economic loss; or
- Including a statement in the notice provided before the start of the plan year that you may reduce or suspend contributions mid-year.
- A supplemental notice is distributed to employees detailing the effective date of the reduction or suspension and procedures for changing their elective deferrals.
- Employees have a reasonable opportunity to change their deferral election before the reduction or suspension occurs.
- The plan is amended to apply the ADP test for the entire plan year in which the reduction or suspension occurs using the current year testing method.
- The plan meets the safe harbor requirements for compensation paid through the effective date of the reduction or suspension.
- The reduction or suspension is effective no earlier than the later of:
- 30 days after the supplemental notice if provided to employees; or
- The date the amendment is signed.
- The business is either:
To illustrate, your safe harbor non-elective 401(k) plan timely sent the notice to employees in November 2022, for the 2023 calendar plan year. The notice included a statement that the business may decide to reduce or suspend contributions during the year. In April 2023, you decide it’s too much to worry about the safe harbor contribution at the end of the year. The supplemental notice is sent to employees on April 14, 2023. The supplement notice explains how the non-elective safe harbor contribution is suspended effective May 14, 2023, and how employees can change their elective deferrals. The plan amendment to apply the ADP test must be signed before May 14th for that to be the effective date. If all these actions occur, then:
- You are responsible for paying the 3% non-elective safe harbor contribution for compensation paid from January 1, 2023 through May 14, 2023.
- The ADP test must be performed taking into account elective deferrals and compensation paid from January 1, 2023 through December 31, 2023.
- The plan is not exempt from top-heavy testing for the 2023 plan year.
There are reduced administrative steps if the reduction or suspension is part of a plan termination in connection with:
- A business transaction in which you become, or cease to be, a member of a controlled group or affiliated service group.
- A substantial business hardship (including operating at an economic loss).
For terminating plans meeting one of these conditions, there is no supplement notice requirement, and the plan is still exempt from the ADP test and the top-heavy test. The only requirement is for the plan to meet the safe harbor requirements for compensation paid through the effective date of the termination.
To illustrate, your safe harbor non-elective 401(k) plan timely sent the notice to employees in November 2022, for the 2023 calendar plan year. In April 2023, you are in negotiations to be purchased by another company closing on May 1, 2023. No supplemental notice, ADP testing or top-heavy testing is required. You are only responsible for paying the 3% non-elective safe harbor contribution for compensation paid from January 1, 2023, through May 1, 2023.
Can a Safe Harbor 401(k) Plan be Amended Mid-Year?
If the amendment affects the content of the previously provided safe harbor notice, a new notice must be sent within a reasonable time before the amendment’s effective date. 30 to 90 days before the effective date is deemed reasonable. If the notice cannot be provided before the effective date, then it must be provided no later than 30 days after the amendment is signed. In addition, employees must be given a reasonable opportunity to change their deferral election before the amendment’s effective date. A 30-day election period is deemed reasonable.
The following are prohibited mid-year changes:
- Increasing the number of years required for full vesting of QACA safe harbor contributions.
- Reducing the number or otherwise narrowing the group of employees eligible to receive safe harbor contributions if the employees have already met the existing eligibility conditions.
- Changing the type of safe harbor plan (e.g., traditional safe harbor to QACA safe harbor).
- Within three months of plan year end, modifying or adding a match formula resulting in an increase of matching contributions or permitting discretionary matching contributions. This change is permitted if made prior to three months before plan year end and the change is retroactive to the beginning of the plan year.
Small Business Owners – Know Your Options!
Safe harbor 401(k) plans can be a great choice for small businesses that have trouble with annual testing. However, they are not for everybody – they can be more expensive than conventional 401(k) plans due to the mandatory contributions. You should weigh their pros and cons vs. a conventional plan before choosing one for your business.