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The Two-Headed Monster, Fairness and Safe Harbor Plans

Greg Carpenter

December 29, 2022


The financial animal known as a 401(k) plan is a mash-up of two tax deferral concepts:

  1. A 401(k) allows employees to defer a portion of their pay into a savings plan. Employees receive a tax benefit and start building a nest egg. Key point: this part is the EMPLOYEE’S MONEY.
  2. A 401(k) allows the employer to transfer money to employees on a tax-deferred basis. The company takes a deduction for the amount contributed and employees receiving the money defer taxes on amounts received. Key point: this part is the COMPANY’S MONEY.

Drop the two concepts into something akin to Dan Aykroyd’s classic “Bass-o-matic” and you have the Internal Revenue Code for retirement plans.

The key takeaway is that the employee money and the company money have to stay together no matter what. Different sources and different owners but tied together like Rosey Grier and Ray Milland in “The Thing with Two Heads.” Sorry for that visual, but I wanted to make a point.

Then the Federal government does something very good, but boy is it complicated.

The Feds correctly assume that the more highly paid employees are the ones making the decision on who gets the company money and they would like to give themselves all of the company money. Also, they assume that more highly paid employees will have more employee money to contribute. The Feds then set rules that give companies incentives to make contributions to the plan on behalf of employees. Make these contributions, collectively known as “Safe Harbor” and the fairness rules are considered met. The net effect: COMPANY MONEY becomes EMPLOYEE MONEY. Great use of tax incentives!

The government is clear and precise on these rules to enforce fairness.

Why do they stop there?

Fairness issues extend beyond the plan contributions. Issues includes investment choice, access to investor education, distribution rules and how plan costs are borne, to name but a few.

If the safe harbor plan concepts works so well, why can’t we extend it to other aspects of retirement plan management?

Ray Milland is violently nodding his head. Unfortunately, he’s just a head – it’s Rosey’s body.

Please let me know what you think in the comment box below.

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