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:
When 401(k) nondiscrimination tests fail, it’s usually business owners that bear the brunt of the consequences. They often receive the largest contribution refunds when the ADP or ACP test fails and make a 3% contribution to non-owners when their plan is top-heavy.
Given these consequences, it is little wonder why business owners find safe harbor 401(k) plans attractive. They help business owners maximize personal contributions while costing about the same as a top-heavy 401(k) plan.
However, safe harbor 401(k) plans aren’t for everybody. Their contribution requirements can make them more expensive than a traditional 401(k) plan and not all plans have trouble passing annual tests.
We get a lot of questions from business owners about safe harbor 401(k) plans. Below is a FAQ with answers to the most common questions we receive. These answers reflect changes made by the Setting Every Community Up for Retirement Enhancement (SECURE) Act. If you are a small business owner, you can use our FAQ to help decide whether a safe harbor 401(k) plan is right for your company.
What are the Employer Contribution Requirements for a Safe Harbor 401(k) Plan?
Safe harbor 401(k) plans require an employer to make either an eligible matching or nonelective contribution to participants.
Safe Harbor Matching Contribution
Two options are available:
- Basic match - 100% match on the first 3% of deferred compensation plus a 50% match on deferrals between 3% and 5% (4% total).
- Enhanced match – Must be at least as generous as the basic match at each tier of the match formula. A common formula is a 100% match on the first 4% of deferred compensation.
Safe Harbor Nonelective Contribution
3% (or more) of compensation, regardless of employee deferrals.
Highly-Compensated Employees (HCEs) can be excluded from these contributions. They must be 100% immediately vested.
What’s a Qualified Automatic Contribution Arrangement (QACA)?
- The employer must make one of the following contributions to plan participants:
- QACA Match – 100% match on the first 1% of compensation deferred and a 50% match on deferrals between 1% and 6% (3.5% total). A more generous match formula is also allowed.
- QACA Nonelective – 3% (or more) of compensation, regardless of employee deferrals.
- QACA contributions can be subject to a vesting schedule - up to a 2-year cliff.
- The default deferral rate of the automatic enrollment feature is subject to the following limits:
- Minimum - 3% for the first year of plan participation, increased by 1% annually until 6% is reached.
- Maximum - 10% for the first year of plan participation. For subsequent years, the SECURE Act raised the cap to 15%.
- A Qualified Default Investment Alternative (QDIA) must be used to invest participants that fail to make affirmative investment election themselves.
Are Profit-Sharing Contributions Made to a Safe Harbor 401(k) Plan Subject to Testing?
Yes. Regardless of a 401(k) plan’s safe harbor status, a profit-sharing contribution must satisfy the 401(a)(4) nondiscrimination test. While a pro-rata or permitted disparity formula will generally pass this test automatically, a “new comparability” formula must pass the 401(a)(4) “general test.”
Can an Additional Discretionary Match Also Exempt from the ACP Test?
It depends. If an employer wants to make a discretionary match in addition to safe harbor contributions, it must meet two conditions to be exempt from the ACP test:
- The match formula cannot be based on more than 6% of deferred compensation.
- The match cannot exceed 4% of deferred compensation in total.
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 can be subject to a vesting schedule – up to a 3-year cliff or 6-year graded schedule.
Are Safe Harbor 401(k) Plans Always Exempt from Top Heavy Testing?
No. A safe harbor 401(k) plan would be subject to top-heavy testing for plan years in which one or more of the following events occur:
- Safe harbor contributions are subject to longer eligibility requirements than employee deferrals.
- A profit-sharing contribution (including forfeiture reallocations) is made by the employer.
- A match that’s not exempt from the ACP test is made by the employer.
- Voluntary (non-Roth) after-tax contributions are made by participants.
However, all employer contributions made during the plan year will count towards satisfying the 3% top-heavy minimum contribution (if applicable).
What are the Participant Disclosure Requirements for a Safe Harbor 401(k) Plan?
For plan years beginning after December 31, 2019, only match-based safe harbor 401(k) plans are subject to a participant disclosure requirement (the SECURE Act made nonelective-based safe harbor plans exempt).
If 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 Establishing 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 wage deferrals. That means the deadline for establishing 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 is necessary to convert a traditional 401(k) into a safe harbor plan. The deadline for executing 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, the safe harbor notice must be distributed sooner - 30-90 days before the start of the plan year.
Safe Harbor Nonelective – The SECURE Act made this amendment deadline much more flexible. 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).
Is it Possible to Reduce or Suspend Safe Harbor Contributions Mid-Year?
Yes. Employers can reduce or suspend either safe harbor match or nonelective contributions (as applicable) mid-year when all of the following conditions are met:
Either of the following conditions apply:
The employer is operating at an economic loss.
The safe harbor notice provided before the start of the plan year includes a statement that the employer 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 in which the reduction or suspension occurs using the current year testing method.
Can a Safe Harbor 401(k) Plan be Amended Mid-Year?
It depends. Employers can amend a safe harbor 401(k) plan mid-year when all of the following conditions are met:
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.
What Tax Credits Apply to a Safe Harbor 401(k) Plan?
Small businesses (up to 100 employees) can earn a tax credit to cover 50% of the ordinary and necessary costs of starting a new retirement plan – including a safe harbor 401(k) plan. The SECURE Act increased its annual cap from $500 to the greater of:
the lesser of
$250 multiplied by the number of non-highly compensated employees eligible for plan participation or
This tax credit is available for up to three years.
Small businesses can earn an additional $500 tax credit by adding an automatic enrollment feature to either a new or existing 401(k) plan. The credit is available for each of the first three years the feature is effective.
Small Business Owners – Know Your Options!
Safe harbor 401(k) plans can be a great choice for small businesses that have trouble passing 401(k) testing. However, they are not for everybody – they can be more expensive than traditional 401(k) plans. Small business owners should weigh the pros and cons of these plans before choosing one for their company.