Small Business 401(k) Blog

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 mandatory contribution and participant disclosure requirements are met. This trade-off is worth it for many business owners, who often bear the brunt of the consequences when their 401(k) plan fails testing. However, a safe harbor 401(k) plan is not the best fit for every small business. They can cost more than a traditional 401(k) plan, but offer less plan design flexibility – making it harder for some business owners to meet their plan priorities

All 401(k) plan contributions have deposit deadlines – and it’s up to 401(k) fiduciaries to meet them. Yet, many employers are unclear about the deadlines applicable to their 401(k) plan. That confusion can easily lead to late contributions. When that happens, there are always consequences for the employer. They range from mild (losing a tax deduction, making participants whole for lost earnings) to severe (plan disqualification, IRS and/or civil penalties). Fortunately, these consequences are easily avoided with some basic education.

One of most effective ways an employer can persuade their employees to participate in a 401(k) plan is by matching a portion of their pre-tax or Roth 401(k) salary deferrals.  This is unsurprising when you consider matching contributions are like a guaranteed return on salary deferrals - or “free” money. 

Today, most 401k plans operate on a calendar-based plan year cycle. March 15 was an important date for many of these plans – it was the deadline to make any corrective distributions due to a failed 2015 plan year Average Deferral Percentage (ADP) or Average Contribution Percentage (ACP) test in order to avoid a 10% IRS excise tax. Failing an ADP/ACP test is not fun. Highly Compensated Employees (HCEs) don’t want their 401k contributions refunded (and out-of-pocket taxes increased), while employers don’t want angry HCEs or the stress of correcting a failed ADP/ACP test by March 15. Although approximately 30% of 401k plans subject to ADP/ACP testing fail, it’s an outcome most small businesses want to avoid. Below are steps a 401k fiduciary can take to do that.

Each plan year, ERISA requires every 401(k) plan to complete certain tests to confirm they do not discriminate in favor of Highly Compensated Employees (HCEs) or exceed IRS contribution limits. Generally, this annual testing is completed as soon as possible following the close of a plan year. For 401k plans with a plan year that ended December 31, 2018, that means now. While most employers hire a professional third-party administrator (TPA) to complete this work, all employers should understand testing basics to confirm all necessary tests are completed and any failed tests are corrected each year.   Otherwise, costly penalties, plan disqualification or fiduciary liability are more likely.

At Employee Fiduciary, March is a busy month. And no, I’m not talking about putting together our NCAA brackets. Corporate tax returns are due March 15, which means we are helping our clients analyze the deductibility of 2012 contributions. We are busy completing 401k plan testing and compliance. In a perfect world, all employees would make the maximum contributions to their plan and reap the rewards come retirement time. But for many employees, putting aside money for retirement is difficult - many need their paycheck in its entirety just for everyday living expenses. On the other hand, highly compensated employees have the ability to make larger contributions to the plan. The IRS has rules that limit deductibility of plan contributions. Basically, the wealthy can max out only if the less well compensated make significant contributions as well. Because of this, we have seen many of our own clients choose to invest in a 401k plan with “safe harbor” provisions. The 401k safe harbor plan allows highly compensated owner-employees to make maximum contributions even if their employees make smaller contributions - or no contribution at all. With this kind of plan in place, a small business owner doesn’t run the risk of failing a non-discrimination test (safe harbor plans don’t require discrimination testing) and triggering a refund of contributions, which then are taxed as part of personal income. But what’s the catch? And does it violate the principles of frugality?