The Frugal Fiduciary Small Business 401(k) Blog
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Safe harbor 401(k) plans are the most popular type of 401(k) sponsored by small businesses today. They can automatically pass Actual Deferral Percentage (ADP), Actual Contribution Percentage (ACP), and top heavy testing, which helps business owners maximize personal contributions. To achieve safe harbor status, a business must meet certain employer contributions and participant disclosure requirements. For many owners, that trade-off is well worth the cost. Here’s why:
It’s impossible to complete annual 401(k) plan testing accurately without a clear understanding of the plan sponsor’s ownership structure. This information is used to determine the company’s controlled or affiliated service group status as well as the Highly Compensated Employee (HCE) and key employee status of plan participants. To make these determinations properly, certain “family attribution” rules must be applied correctly. These IRS rules exist to thwart ownership structures that would otherwise permit a 401(k) plan to discriminate in favor of business owners.
The day-to-day operation of all 401(k) plans must be governed by a written plan document that meets Internal Revenue Code requirements. Occasionally, 401(k) plan documents will require an amendment to reflect law changes or employer intentions. The Internal Revenue Service (IRS) has strict rules for plan amendments. It’s important for employers to understand them. Otherwise, they could miss the chance to make discretionary plan changes, accidentally cut back protected benefits, or face punishment for document non-compliance.
Safe harbor 401(k) plans are the most popular type of 401(k) used by small businesses today. Unlike a traditional 401(k) plan, they automatically pass the ADP/ACP and top heavy nondiscrimination tests when certain contribution and participant disclosure requirements are met. This trade-off is well worth the cost for many business owners, who often bear the brunt of the consequences when their 401(k) plan fails testing.
Small business owners can have dramatically different goals for their 401(k) plan. While some want to maximize key employee contributions, others want to incentivize plan participation by all employees. Business owners have nearly endless options for meeting these goals – many with very different expenses. The process of matching 401(k) goals to available options is called 401(k) plan design.
A 401(k) plan may, but is not required to, allow participants to take a hardship distribution in times of financial stress. This type of 401(k) distribution can be a financial lifeline when someone has nowhere else to turn for cash. Last year, the IRS released a proposed regulation that made several changes to the 401(k) hardship rules, generally relaxing how and when these distributions may be taken. Both employers and 401(k) participants should understand how the regulation will affect their retirement plan.