A safe harbor 401(k) is a win-win for both employers and employees. This type of retirement plan allows employers to pass up the cumbersome nondiscrimination testing requirements that traditional 401(k) plans are subject to, while also benefiting employees by requiring mandatory employer contributions.
For many small businesses, a safe harbor 401(k) can be a great way to provide retirement plan benefits to your employees.
IN THIS ARTICLE:
● A safe harbor 401(k) is not subject to the complex nondiscrimination tests that traditional 401(k) plans must undergo each year.
● Employers must make mandatory contributions to their employees’ safe harbor 401(k) plans. There are 3 employer contribution options.
● The deadline to set up a safe harbor 401(k) plan for your business is October 1.
Traditional 401(k) vs. Safe Harbor 401(k): What’s the Difference?
Safe harbor 401(k) plans do not require annual nondiscrimination testing.
A traditional 401(k) plan must undergo complex annual nondiscrimination tests called Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. These tests are intended to ensure that the contributions made for and by non-highly compensated employees (NHCE) are proportional to highly-compensated employees (HCE). Traditionally, your plan’s third-party administrator conducts these tests.
For 2022, a HCE is generally defined as an employee who made more than $135,000 in the preceding year or who owns more than 5% of the company (or is the spouse, child, parent, or grandparent of someone who owns more than 5% of the company ).
If a plan fails to pass these tests, corrective action must be taken or else the company will face IRS penalties.
A safe harbor 401(k), on the other hand, does not require nondiscrimination tests.
Employees are immediately vested in safe harbor 401(k) plans.
Under a traditional 401(k) plan, employers can decide to set a vesting schedule, requiring employees to work for the company for a certain number of years before gaining full ownership of 401(k) contributions made by the employer.
However, with a safe harbor 401(k) plan, employees are immediately vested.
Employers must contribute to an employee’s safe harbor 401(k) plan.
Employers are not required to match traditional 401(k) contributions. However, you must offer a matching contribution to your employees’ safe harbor 401(k) plans. There are 3 employer contribution options, which we cover below.
Employees can contribute up to $20,500 in 2022.
This is where both 401(k) plans are the same: this $20,500 employee elective deferral limit applies to both traditional 401(k) plans and safe harbor 401(k) plans in 2022. Participants aged 50 and over can make additional “catch-up” contributions of $6,500 in 2022.
What are the employer contribution options for safe harbor 401(k) plans?
Employers must make mandatory contributions to their employees’ safe harbor 401(k) plans.
There are 3 employer contribution options:
- Basic match: The employer matches 100% of employee contributions up to 3% of an employee’s compensation. After that, the employer matches 50% of any additional contributions made by the employee, up to 5% of that employee’s annual compensation.
- Enhanced match: An enhanced match must meet or exceed the basic match requirements. Generally, an employer provides a 100% match of up to 4% of an employee’s pay.
- Nonelective match: An employer contributes to all employee plans, regardless of whether or not that employee contributes. The employer contributes at least 3% of the employee’s salary to the plan.
What is the cost of operating a safe harbor 401(k) plan?
It depends. While that may not be the concrete answer you’re looking for, the cost your business will incur depends on the participation of employees. If more of your employees contribute to their plans, the more you’ll contribute through your matches.
If you choose the nonelective match option, however, you can reliably forecast your company’s annual safe harbor 401(k) plan contributions for the year.
Because of the complexities of setting up and managing a 401(k) plan, many companies look to a third-party administrator to handle these responsibilities. You’ll face an initial set-up fee for the plan, yearly fees for plan management, and a per-participant fee.
What is the deadline to set up a safe harbor 401(k) plan?
The deadline to set up a safe harbor 401(k) plan is October 1.Work with our Landmark Financial advisors to determine if a safe harbor 401(k) plan is the best option for your business.