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Safe Harbor 401k Plan: What Is It? Is It for You?

By Ashley Kilroy · September 30, 2021 · 7 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

Safe Harbor 401k Plan: What Is It? Is It for You?

Safe harbor 401(k) plans enable companies to sidestep the annual IRS testing that comes with traditional 401(k) plans, in part by providing a contribution to all employees’ retirement accounts that vests immediately.

Typically a perk used to attract top talent, safe harbor 401(k) plans are a way for highly compensated employees, like company executives and owners, to save more than a traditional 401(k) plan would normally allow.

With traditional 401(k) plans, contributions from highly compensated employees can’t comprise more than 2% of the average of all other employee contributions, in addition to other restrictions. However, with safe harbor 401(k) plans, those limits don’t apply.

Keep reading to learn more about safe harbor rules, why companies use these plans, along with the benefits, drawbacks, and relevant deadlines.

Recommended: What is a 401K Plan and How Does it Work?

Safe Harbor 401(k) Plans Defined

A 401(k) safe harbor plan behaves much the same way a traditional 401(k) plan does — but with a twist. In both cases, eligible employees can use the plan to deposit pre-tax funds for their retirement and employers can contribute matching funds.

But with an ordinary 401(k) retirement plan, companies must submit to annual nondiscrimination regulatory testing by the IRS to ensure that the company plan doesn’t treat highly compensated employees (HCEs) — generally defined as earning at least $130,000 a year or owning 5% or more of the business — more favorably than others.

But the testing process is complex and onerous, as we’ll cover below in the section on safe harbor 401(k) rules.

An alternative is to set up a safe harbor 401(k) plan with a safe harbor match. This allows a company to skip the annual IRS testing — and avoid imposing restrictions on employee saving — by providing the same 401(k) contributions to all employees, regardless of title, salary, or even years spent at the company. And those funds must vest immediately.

This is an important benefit, because in many cases, employer contributions to ordinary 401(k) plans vest over time, requiring employees to stay with the company for some years in order to get the full value of the employer match. Often, if you leave before the employer contributions or match have vested, you may forfeit them.

For smaller companies, it may be worth making the extra safe harbor match contributions in order to avoid the time and expense of the IRS’s annual nondiscrimination testing. For larger companies, giving all employees the same percentage contribution could be expensive. But the upside is that highly paid employees can then make much larger 401(k) contributions without running afoul of IRS rules, a real perk for company leaders. In addition, 401(k) safe harbor plans are typically less expensive to set up than traditional plans.

What Are Nondiscrimination Tests, and How Do They Affect Your 401(k) Plan?

To understand the benefit of safe harbor plans, it helps to see what employers with traditional 401(k) plans are up against in terms of following IRS rules and submitting to the annual nondiscrimination tests. To confirm there is no compensation discrimination, the company must conduct Actual Deferral Percentage (ADP), Actual Contribution Percentage (ACP), and Top Heavy tests.

If the company fails one of the tests, it could mean considerable administrative hassle, plus the expense of making corrections, and potentially even refunding 401(k) contributions.

Before explaining the details of each test, here’s how the IRS defines highly compensated employees (HCEs) and non-highly compensated employees (NHCEs).

To be a HCE:

• The employee must own more than 5% of the company at any time during the current or preceding year (directly or through family attribution).

• The employee is paid over $130,000 in compensation from the employer during the current or previous year. The plan can limit these employees to the top 20% of employees who make the most money.

Employees who don’t fit these criteria are considered non-highly compensated. The nondiscrimination tests are designed to assess whether top employees are saving substantially more than the rank-and-file staffers.

• The Actual Deferral Percentage (ADP) test measures how much income highly paid employees contribute to their 401(k), versus staff employees.

• The Actual Contribution Percentage (ACP) test compares employer retirement contributions to HCEs versus the contributions to everyone else.

According to the IRS, the terms of the ADP test — which compares the amounts different employees are saving in their 401(k)s — are met if the ADP for highly compensated employees (HCE) doesn’t exceed the greater of:

• 125% of the deferral percentage for ordinary, i.e., non-highly compensated employees (NHCEs)

Or the lesser of:

• 200% of the deferral percentage for the NHCEs

• or the deferral percentage for the NHCEs plus 2%.

The ACP test is met if the deferral percentage for highly compensated employees doesn’t exceed the greater of:

• 125% of the deferral percentage for the NHCEs,

Or the lesser of:

• 200% of the deferral percentage for the group of NHCEs

• or the deferral percentage for the NHCEs plus 2%.

Last, the top-heavy test measures the value of the assets in all company 401(k) accounts, total. If the 401(k) balances of “key employees” account for more than 60% of total plan assets, the 401(k) would fail the top heavy test. The IRS defines key employees somewhat differently than highly compensated employees, although both groups are similar in that they earn more than ordinary staff.

As you can see, maintaining a traditional 401(k) plan, and meeting these requirements each year, can be a burden for some companies. Fortunately, it’s possible to set up a safe harbor 401(k) plan, avoid the annual nondiscrimination tests, and provide additional 401(k) savings for employees.

Requirements for a Safe Harbor 401(k)

To fulfill the safe harbor 401(k) requirements, the employer must make qualifying 401(k) contributions (a.k.a. the safe harbor match) that vest immediately. The company contributes to employees’ retirement accounts in one of three ways:

Non-elective: The company contributes the equivalent of 3% of each employee’s annual salary to a company 401(k) plan, regardless of whether the employee contributes.

Basic: The company offers 100% matching for the first 3% of an employee’s 401(k) plan contributions, plus a 50% match for the following 2% of an employee’s contributions.

Enhanced: The company offers a 100% company match for all employee 401(k) contributions, up to 4% of a staffer’s annual salary.

Safe Harbor Contribution Limits

Just like traditional 401(k) plans, the maximum employee contribution limit for a safe harbor plan is $19,500 per year. If you are over 50, you would be eligible for an additional $6,500 catch-up contribution, if your plan allows it.

But in a safe harbor plan, a company owner can reserve the maximum $19,500 (in 2021) for their plan contribution and also boost contribution payments to valued team members up to an individual profit-sharing maximum amount of 100% of their compensation, or $58,000 ($64,500 for those over age 50) — whichever is less.

Regular employees are allowed the standard maximum contribution limit of $19,500, plus anyone over age 50 can contribute an extra “catch-up” amount of $6,500. Those are the same maximum contribution ceilings as regular 401(k) plans.

Benefits of Offering a Safe Harbor 401(k) Plan

By creating a safe harbor 401(k) plan, a business owner can potentially attract and maintain highly skilled employees. Employees are attracted to higher retirement plan contributions and the ability to optimize retirement plan contribution amounts, ensuring more money for long-term retirement savings.

Plus, a safe harbor 401(k) plan can also help business owners save money on the compliance end of the spectrum. For example, companies save on regulatory costs by avoiding the costs of preparing for a nondiscrimination test (and the staff hours and training that goes with it).

There are some additional upsides to offering a safe harbor 401(k) retirement plan, for higher paid employees and regular staff too.

Playing catch up. If a company owner, or high-level managers, historically haven’t stowed enough money away in a company retirement plan, a safe harbor 401(k) plan can help them catch up. The same may be true, although to a lesser degree, for regular employees.

The spread of profit. Suppose a company has a steady and robust revenue stream and is managed efficiently. In that case, company owners may feel comfortable “spreading the wealth” with not only high-profile talent but rank-and-file employees, too.

Encourage retirement savings. Suppose a company is seeing weak contribution activity from its rank-and-file employees. In that case, it may feel more comfortable going the safe harbor route and at least guaranteeing minimum 401(k) contributions to employees while rewarding higher-value employees with more lucrative 401(k) plan contributions.

Potential Drawbacks of a Safe Harbor 401(k) Plan

Safe harbor 401(k) plans have their downsides, too.

Expense. The matching contribution requirements can add up to a hefty expense, depending on employee salaries. And because employees are vested immediately, there’s no incentive to stay with the company for a certain period.

Termination fees. If a company introduces a safe harbor 401(k) plan, it must commit to it for one calendar year, no matter how the plan is performing internally. Even after a year, 401(k) plan providers (which administer and manage the retirement plans) usually charge a termination fee if a company decides to pull the plug on its safe harbor plan after one year.

Filing Deadlines for a Safe Harbor 401(k) Plan

Companies that opt for a safe harbor 401(k) plan have to adhere to strict compliance filing deadlines. These are the dates worth knowing.

October 1: That’s the deadline for filing for a safe harbor 401(k) for the current calendar year. This deadline meets the government criteria of a company needing to have a safe harbor 401(k) in operation for at least three months in a 12 month period, for the first year operating a safe harbor plan.

November 1: For companies with a safe harbor plan already in place, November 1st represents the last date a business can change the structure of a safe harbor plan. Regulators stipulate the November 1 deadline date for plan changes so notices can be transmitted to employees by December 1, giving them time to prepare for the next calendar year.

December 1: By this date, all companies — whether they’re rolling out a brand new safe harbor plan or are administering an existing one — must issue a formal notice to employees that a safe harbor 401(k) will be offered to company staffers.

January 1: The date that all safe harbor 401(k) plans are activated.

For companies that currently have no 401(k) plan at all, they can roll out either a traditional 401(k) plan or a safe harbor 401(k) plan at any point in the year, for that calendar year.

The Takeaway

Companies that don’t want the regulatory obligations of a traditional 401(k) plan, and want to prioritize talent acquisition and retention may want to consider safe harbor 401(k) plans.

These plans allow an employer to bestow extra retirement benefits on high-value employees, making an overall compensation package more desirable. But a business owner needs to weigh the pros and cons of a safe harbor 401(k) plan because, in some cases, it can be expensive for a company to maintain.

For business owners who aren’t sure which retirement plan is suitable for their company and their employees, it can be helpful to do some research. With SoFi Invest®, you can also open an online retirement account to gain access to more resources, including complimentary access to financial advisors.

Planning for retirement? Learn how working with a financial planner can help you reach your goals.


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