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April 6, 2023 | 0 min read

The Ultimate Guide to Safe Harbor 401(k) Plans

Key Takeaways

  • Safe harbor 401(k) plans can automatically pass certain annual tests with mandatory contributions and participant notices, benefiting small businesses and their employees.
  • There are several mandatory contribution options to fulfill safe harbor 401(k) requirements, offering flexibility in meeting plan goals.
  • Understanding the various safe harbor options enables employers to choose the most cost-effective solution that aligns with their 401(k) plan objectives.

Safe harbor 401(k) plans are the most popular type of 401(k) used by small businesses today. To understand its popularity, think of a 401(k) plan as a cake given to a business by the IRS. The IRS knows that the business owner loves cake and may try to keep it all to himself. Therefore, the IRS informs the owner that he must share the cake and the owner can have more of the cake if he ensures his employees are also eating cake.

However, one employee is on a diet, another is gluten-intolerant and a third had a bad, past experience with cake and won’t eat it again. Even though the owner tries to get employees to eat cake, only a few of them are and that is limiting how much cake the owner can eat. Doesn’t sound fair to the cake-loving small business owner.

With a safe harbor 401(k) plan, the IRS allows the owner to eat as much as cake as he wants (up to the IRS limit). The trade-off is that he must tell employees that cake is available and that he provides cake to the employees who ask for it. This essentially is the difference between a conventional 401(k) plan and a safe harbor 401(k) plan.

Although safe harbor 401(k) plans are often the preferred choice for small businesses, they may not be the best fit for every business. In some cases, a conventional 401(k) plan may better meet the goals and budget of a business. It is important for businesses to carefully consider their options and choose the plan that best meets their needs.

What is a Safe Harbor 401(k)?

A safe harbor 401(k) plan differs from a conventional 401(k) plan through two general requirements:

    1. a mandatory contribution
    2. participant notices

A safe harbor 401(k) is considered to automatically pass certain annual tests by satisfying these two requirements. This allows highly compensated employees (HCEs), including the business owner, to maximize their annual contributions without fear of refund or additional employer contributions due to failed testing which is possible in a conventional 401(k) plan.

Safe Harbor Mandatory Contributions

You can decide which of the following safe harbor options best meets your needs and expectations during the plan design process. A safe harbor 401(k) plan may either be a traditional safe harbor or a Qualified Automatic Contribution Arrangement, also known as “QACA,” safe harbor.  

In deciding which to choose, it’s important for business owners to understand the differences between traditional safe harbor and QACA safe harbor. Each option can significantly impact the cost and complexity of the plan. A qualified retirement plan provider, like Employee Fiduciary, can assist in this evaluation. If you’re looking for a 401(k) provider that has helped many employers go through this analysis, reach out to our sales team

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Traditional Safe Harbor

When the safe harbor 401(k) plan was initially created, the only option was the traditional safe harbor. Employers using a traditional safe harbor have two options in satisfying the safe harbor mandatory contribution:

    1. match
    2. non-elective contribution

Match in general is based on elections made by participants to defer compensation into the plan and how much. If a participant elects not to defer, he or she doesn’t receive a match. Non-elective contributions are not based on elections by the participants to defer compensation into the plan. If a participant elects not to defer, he or she may still receive a non-elective contribution. The employer makes the decision on which option is best for their circumstances. 

Traditional Safe Harbor Match

This option requires the employer to match 100% of the first 3% of deferred compensation and an additional 50% on the next 2% of deferred compensation (4% of compensation total). This is also called the “basic match.” 

Example

If a participant elects to defer 4% of her $50,000 compensation, then she would be entitled to $1,750 (3.5% x 50,000) of match. If the same participant deferred 8% of her compensation, then she would receive the max match of $2,000 (4% x 50,000). 

What if an employer wants to provide more match than the numbers above? Would an additional match still meet the safe harbor mandatory contribution? Yes, the IRS allows an “enhanced match” which still meets the safe harbor mandatory contribution as long as it equals or exceeds the basic match at each tier. A common enhanced match is 100% match on the first 4% of compensation. 

Example

If a participant elects to defer 4% of her $50,000 compensation, then she would be entitled to $2,000 (4% x 50,000) of match. If the same participant deferred 8% of her compensation, then she would still receive $2,000 (4% x 50,000) of match.

Traditional Safe Harbor Non-Elective

The non-elective option permits an employer to contribute 3% of the employee’s compensation, regardless of how much the employee themselves contributed. An employer also has the discretion to contribution more than 3% of the employee’s compensation and still satisfy the safe harbor mandatory contribution. This option is best for an employer who doesn’t want to be concerned with how much participants are deferring. 

Example

If compensation for all eligible employees equals $350,000, then the contribution for that year would be $10,500. 

QACA Safe Harbor

The QACA safe harbor was created after the traditional safe harbor as an alternative to provide added flexibility which may be beneficial to certain employers. The QACA safe harbor has a lower mandatory contribution and permits a vesting schedule. In exchange, the plan must comply with an automatic enrollment feature.

The QACA safe harbor has the same two mandatory contribution options as a traditional safe harbor:

    1. match
    2. non-elective contribution

QACA Safe Harbor Match

The QACA match option is lower than the traditional match option. The QACA match option requires employers to match 100% of the first 1% of deferred compensation, plus 50% on the next 5% of deferred compensation, totaling 3.5%. 

Example

If a participant elects to defer 4% of her $50,000 compensation, then she would be entitled to $1,250 (2.5% x 50,000) of match. If the same participant deferred 8% of her compensation, then she would receive the max match of $1,750 (3.5% x 50,000). 

The IRS also permits the “enhanced match” option for a QACA safe harbor, such as 100% match on the first 4% of compensation.

Example
If a participant elects to defer 4% of her $50,000 compensation, then she would be entitled to $2,000 (4% x 50,000) of match. If the same participant deferred 8% of her compensation, then she would still receive $2,000 (4% x 50,000) of match. 

In addition, an employer could apply a vesting schedule requiring employees to work up to two years with the business before they are fully entitled to their match. This vesting feature is not available in a traditional safe harbor plan. 

Example

An employee is automatically enrolled in a QACA 401(k) plan when they begin at the employer. The employee decides to leave after only one and a half years of employment. At that time, the employee has received $3,100 in QACA safe harbor match. Upon termination of employment, the $3,100 is forfeited and may be used by the employer to fund future QACA safe harbor match for other employees. 

QACA Safe Harbor Non-Elective

The QACA non-elective option is identical to the traditional non-elective option: 3% (or more) of the employee’s compensation, regardless of how much the employee contributed. The difference for the QACA safe harbor is the ability to have a vesting schedule on the QACA safe harbor contributions.

QACA safe harbor non-elective contributions, like match, can apply a vesting schedule requiring employees to work up to two years with the employer before they are fully entitled to their non-elective contribution. In other words, any employees leaving the business before working up to two years would forfeit their QACA safe harbor contributions. 

The Ideal 401(k) Plan for Small Businesses

Which Safe Harbor Contribution Option is Better?

There is no “right” answer. The answer depends on the circumstances for each employer.

Example

An employer has compensation for all eligible employees totaling $350,000. The business owner decides to offer a safe harbor 401(k) plan. If the owner chooses a traditional safe harbor match and all employees defer enough to receive the full match, the match contribution would be $14,000 (350,000 x 4%).

On the other hand, if the owner chooses a QACA safe harbor match, the contribution is only $12,250 (350,000 x 3.5%). In addition, any employees leaving the employer before working up to two years (as selected by the employer) would forfeit their QACA safe harbor match.

Under these circumstances – all employees defer enough to receive the full match – the lowest contribution option would not be a match, but instead the non-elective contribution. Under either the traditional or QACA safe harbor, the non-elective contribution would be $10,500 (350,000 x 3%). Further, the QACA safe harbor prevents employees from receiving their non-elective contribution if they have worked for the employer for less than two years.

However, what is the probability that all employees defer enough to receive the full match? It may be more realistic for an employer to project that only half of the employees defer at all into the plan. The safe harbor match may only be $7,000 in such circumstances; less expensive than using the non-elective contribution option.

The decision of whether to use a traditional or QACA safe harbor and whether to use a match or non-elective contribution should take into account multiple factors depending upon each employer’s circumstances. At Employee Fiduciary, we are happy to assist in this analysis. 

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Participant Notices

The other general requirement for using a safe harbor 401(k) plan is sending participant notices. Participant notices or disclosures enable employees to make timely and informed decisions about their 401(k) accounts. The notices for safe harbor 401(k) plans must contain specific information about the mandatory contribution and other features. Don’t worry, you’re not out on your own for this. A good 401(k) provider will do the heavy lifting for you. 

Traditional Safe Harbor Match/QACA Safe Harbor Match

Whether under the traditional or QACA, all safe harbor match plans must send a participant notice to employees prior to their initial plan eligibility. The notice explains to employees how much match they would receive depending upon how much the employee themselves contributed. Other plan features and details relating to elective deferrals, match and any other contributions are included as well. Further, participant notices must generally be sent 30-90 days before the start of each new plan year (typically the calendar year).

The participant notices for the QACA safe harbor must also include information about the automatic enrollment feature. 

Traditional Safe Harbor Non-Elective

A traditional safe harbor non-elective plan is generally exempt from the participant notice requirement. The notice is not critical here. Employees will receive a non-elective contribution, regardless of how much compensation, if any, they themselves defer into the plan. Different from match, there is no action needed by participants to receive the non-elective contribution. 

QACA Safe Harbor Non-Elective

A QACA safe harbor non-elective plan is still required to send participant notices, because of the automatic enrollment feature. Notices to participants explaining the automatic enrollment features and potential action required must still be sent to participants prior to their initial plan eligibility and 30-90 days before the start of each new plan year. 

Having Trouble Deciding? The “Maybe” Notice

Maybe a safe harbor plan design is right for you, but maybe not. You just can’t decide. There is an alternative for you! You are still required to send participant notices generally 30-90 days before the start of each new plan year. However, the notice informs the employees that you are considering a safe harbor plan design and that you have until 30 days prior to the plan year end to make the decision. This is why it is referred to as the “maybe” notice. 

If the employer decides a traditional or QACA safe harbor non-elective plan is the proper decision, a non-elective contribution equal to 3% of the employee’s compensation must be made for that plan year. Whether or not the employer decides to be a safe harbor plan, the decision must be made and a supplemental notice must be sent to the participants informing them of the decision at least 30 days prior to the plan year-end. The advantage of the “maybe” notice is that the employer gets to choose on a year-by-year basis whether or not safe harbor status is right under the specific circumstances. 

Example

You can’t decide whether a traditional safe harbor non-elective plan design is best for your circumstances. While you consider the decision, a notice is sent to participants in November 2022, informing them of the potential safe harbor selection for the 2023 plan year. Towards the end of 2023, you decide the safe harbor design is best, because a preliminary run of the 2023 annual testing was performed and the plan is failing certain tests.

Utilizing the safe harbor allows HCEs, including the business owner, to maximize their annual contributions without fear of refunds due to failed testing. At least 30 days prior to the end of 2023, the employer sends a notice to participants informing them of the non-elective contribution equal to 3% of their 2023 compensation. On the other hand, if the preliminary results of the 2023 annual testing predict the plan is passing, then a notice to participants informing them that the plan will not be a safe harbor plan design in 2023 is due at least 30 days prior to the end of 2023. 

Getting Started

New Plans

A safe harbor 401(k) plan generally needs to be in place for the entire plan year. However, you can adopt a new safe harbor 401(k) plan if there are at least three months for participants to have the opportunity to make elective deferrals. That means the deadline for employers to adopt a new calendar-based safe harbor plan is October 1st.

However, most 401(k) providers have an earlier deadline to allow time for the plan setup process to be finished before the October 1st IRS deadline. Be on the lookout for that when researching providers.

Existing 401(k) Plan

If you would like to add either traditional or QACA safe harbor match to an existing 401(k) plan, you need to wait until the following plan year. But don’t wait until the very end of the year! Both traditional and QACA safe harbor match plans must distribute a notice to participants usually within 30-90 days before the start of the plan year. Your 401(k) provider should be with you every step of the way as a formal plan amendment must be adopted to convert a conventional 401(k) into a safe harbor 401(k).

If you would like to add the safe harbor non-elective to an existing 401(k) plan, you can actually wait until the last day of the plan year following the plan year in which the plan will be safe harbor! However, to keep the safe harbor non-elective contribution at 3% of compensation, you only have up to 30 days before the close of the current year to make the safe harbor election. If you wait until you are within 30 days of the end of the current year or into the following year, the safe harbor non-elective contribution increases to 4% of compensation.

Why would you want to convert a conventional 401(k) plan into a safe harbor non-elective plan after the plan year is over? Assume you failed annual testing and HCEs will need to receive refunds. It may be cost efficient to convert the conventional 401(k) plan to use the non-elective safe harbor at 4% of compensation instead. 

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Tip

We don’t recommend waiting until the very end of the following plan year to make the safe harbor non-elective switch. The practical deadline for making the switch is the employer’s tax filing deadline (with extensions). If the switch is made after the employer’s tax filing deadline, then the safe harbor non-elective contribution will not be tax deductible for the applicable year. 

Example

An employer’s tax deadline with extensions for the 2023 calendar plan year is September 15, 2024. If the plan switches to the non-elective safe harbor after September 15, 2024, the required contribution of 4% of compensation would not be deductible for the 2023 tax year.

Optional 401(k) Plan Features

When choosing the right 401(k) plan for your business, it’s important to consider what options are best for your employees as well as IRS requirements and limitations. These options are generally the same for conventional 401(k) plans or safe harbor 401(k) plans.

During the plan design process, you’ll be able to make decisions regarding the following features: 

While these options may seem overwhelming, a qualified retirement plan provider, like Employee Fiduciary, will walk you through this decision-making process and help you make choices that best meet your goals for the plan and will ensure any requirements are met.

Save up to $16,500 on your taxes.

Fees

When signing up for a small business 401(k) plan, safe harbor or not, you can almost always expect to pay two kinds of fees: administrative and investment, or asset-based, fees.

Administrative fees, typically a quarterly or monthly fee, cover the “back-office” tasks required to run a 401(k) plan. Investment fees in a 401(k) plan can vary widely, from as low as 0.03% to as high as 2% of plan assets.

Typically, the cost of a safe harbor 401(k) plan does not differ from the cost of a conventional 401(k) plan. Employee Fiduciary charges the same fee for all plan design options. 

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Tip

As the plan sponsor, you have a fiduciary responsibility to only pay “reasonable” 401(k) fees. Make sure to choose a provider that discloses all fees and has no hidden ones!

Is a safe harbor 401(k) plan right for your business?

Let’s return to the 401(k) plan being a cake given to a business by the IRS. Does it make sense to use a safe harbor 401(k) plan (more cake for the owner, but with additional parameters) or is that business free to eat cake through a conventional 401(k) plan (no additional parameters)? 

Reasons to choose a safe harbor 401(k) plan:

    • The employees aren’t eating enough cake. The plan will likely fail annual testing resulting in refunds to HCEs. A safe harbor plan allows HCEs to maximize their annual contributions without fear of refunds due to failed testing. In other words, the HCEs can eat as much as cake (up to IRS limits) as desired. 

    • The owner has eaten too much cake in the past and has a weight problem. The IRS wants to ensure employees are getting some of the cake, so they have an annual test called the “top heavy” test. The impact of a “top heavy” plan is a mandatory contribution which coincidentally is the same as the safe harbor non-elective contribution. The safe harbor match plans are also considered to satisfy the “top heavy” test. In other words, the owner can have a weight problem without impacting how much cake is needed for the employees. 

    • More cake for everyone! Business owners who want to offer a 401(k) plan with generous benefits for recruiting and retaining talented employees. 

Reasons to choose a conventional 401(k) plan:

    • Employees love their cake. As soon as it enters the break room, the cake is gone. The plan will have no trouble passing annual testing. In addition, the owner keeps in shape, so no worries about the “top heavy” test. 

    • The business owner wants to hold off on anyone eating cake until later on to make sure everyone is not too tired. Business owners who want to discourage employee turnover by adding allocation conditions (e.g., 1,000 hours, employment on last day of plan year) or vesting schedule to contributions. Allocation conditions and vesting schedules are not generally allowed for safe harbor 401(k) plans. 

    • Knowing that employees will eat all the cake on the first day, the business owner wants to just provide a little bit of cake at a time. Business owners who want to use a “stretch” match formula (e.g., 25% of elective deferrals up to 10% of compensation) to incentivize employees to make higher elective deferrals. In contrast, the safe harbor match contribution requires a high amount of match on lower elective deferrals.

Frequently Asked Questions

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. Establishing a new calendar-based plan is October 1st. For 2023, Employee Fiduciary's deadline is September 15th in order to timely finish setup.

What Tax Credits Apply to a Safe Harbor 401(k) Plan?

Small businesses can save up to $16,500 on their taxes by starting a Safe Harbor 401(k) plan. All small business tax credits available to conventional 401(k) plans are offered to Safe Harbor 401(k) plans. 

How Much Does a Safe Harbor Plan Cost?

It depends on the provider you choose. Employee Fiduciary's price is $1,500 (for up to 30 employees) for a full-service 401(k) plan and includes all Recordkeeping and TPA services. 

What Are My Safe Harbor Contribution Options?

There are four contribution options: traditional match, traditional non-elective, QACA match, and QACA non-elective.

Additional Resources

SECURE Act 2.0 – A Summary of the Major 401(k) Provisions

SECURE Act 2.0 – A Summary of the Major 401(k) Provisions

SECURE 2.0 makes sweeping changes to 401(k) plans. Employers should understand the most significant provisions to prepare their 401(k) plan for them.

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401(k) Fee Study: 75% of Small Business Plans Pay Hidden Fees

401(k) Fee Study: 75% of Small Business Plans Pay Hidden Fees

“Are my 401(k) fees too high?” is a common question asked by both plan sponsors and participants. Our small business fee study can give some perspective.

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Small Business 401(k) Tax Credits – SECURE 2.0 Updates

Small Business 401(k) Tax Credits – SECURE 2.0 Updates

Discover three small business 401(k) tax credits that can help lower the out-of-pocket cost of starting a small business retirement plan. Plus, read the latest changes due to SECURE 2.0.

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