What Is A Safe Harbor 401k? | Personal Capital
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Safe Harbor 401k

A safe harbor 401k ensures employees equitable contributions, regardless of compensation. Many small businesses sponsor this retirement plan.

Do you own a business where individuals rely on you for their income and benefits? If so, you may be determining the ideal benefits package for your employees if you haven’t done so already. When it comes to providing a retirement plan for members of your company, a wide variety of options are available, with the 401k being one of the most widely known. However, if you decide to supply a 401k plan, it isn’s always a simple process isn’t as several guidelines and rules apply for the various 401k options available. In this article, we’re going to discuss one such option, the Safe Harbor 401k. A Safe Harbor 401k is a type of 401k plan that allows employers to avoid certain annual compliance tests. Safe Harbor 401k provisions can be particularly beneficial for small business.

Let’s take a look at why businesses might elect to use a Safe Harbor 401k, and dive deeper into its guidelines and requirements.

What is a Safe Harbor 401k Plan?

According to the IRS, A Safe Harbor 401k plan is similar to a traditional 401k plan, but, among other things, an employer must make contributions to their employee’s plans that equal the same salary percentage for everyone. The contributions must also be fully vested when made. These contributions may be employer matching contributions, limited to employees who defer, or employer contributions made on behalf of all eligible employees, regardless of whether they make elective deferrals. The Safe Harbor 401k plan is not subject to the complex annual nondiscrimination tests that apply to traditional 401k plans.

Safe Harbor 401k plans ensure the employer contributions are immediately vested to the employee and helps small business owners pass IRS tests by providing equal benefits and access to all employees, no matter the compensation level for each individual employee.

Safe Harbor 401k plans are designed to make participation in 401k plans more equitable, so all employees (not just highly compensated ones) are able to participate. This is why Safe Harbor 401k plans are not subject to many of the IRS nondiscrimination tests.

Guide on IRS Non-Discrimination Tests

By offering Safe Harbor 401k plans to employees, businesses become exempt from having to undergo annual IRS tests that assess the overall fairness of a company’s 401k offering for all employees, and not just the highly compensated individuals.

  1. The Actual Deferral Percentage (ADP) Test: The purpose of this test is to calculate how much money a highly compensated employee (received compensation from the business of more than $125,000 if the preceding year is 2019; and $130,000 if the preceding year was 2020, and, if the employer so chooses, was in the top 20% of employees when ranked by compensation) contributes to a company 401k plan, relative to his or her less-compensated workplace peers, based on employer contributions. To find the ADP, you can simply divide the amount the employee differs by the total income on their W-2 earnings statement.
  2. The Actual Contribution Percentage (ACP) Test: This test is meant to check whether highly compensated employees are deferring significantly more financial assets to a company plan in terms of overall contributions than non highly compensated employees. This percentage can be calculated by dividing the company’s contribution to an employee by his or her W-2 income.
  3. The Top-Heavy Test: This test focuses on “key employees” which are defined by the IRS as officers making over $185,000 in 2020, a 5% owner of the business, or an employee owning more than 1% of the business and making over $150,000. A company fails The Top-Heavy Test when the assets in key employees’ accounts account for more than 60% of all assets held in an employer’s 401(k) plan.
  4. The Coverage Test: Aims to make sure that there is widespread access and participation in a company’s 401(k) plan – from all employees. It does so by measuring the ratio of lower-compensated staffers to higher-compensated ones, using a preset formula. If a company doesn’t have a ratio of 70% of lower-compensated employees to higher-compensated employees, it fails the test.

If an employer fails any one of the above tests, the business may be subject to fines and penalties, and pressure from the IRS to make sure this does not reoccur. Companies who fail one of the nondiscrimination tests can take several actions to comply with the IRS:

  1. Companies can refund highly compensated employees’ contributions to bring the average contribution rates down.
  2. Make Qualified Nonelective Employer Contributions (QNEC) to all non-highly compensated employees to bring their contribution rates up to the minimum percentage required.
  3. A combination of the two solutions above.

Safe Harbor 401k Contribution Options

In order to qualify for a Safe Harbor 401k, employers must offer their employees one of the following contribution methods:

  1. Non-Elective Safe Harbor: Employees get an annual employer contribution of 3% of their salary which is immediately vested whether or not the employee contributes to the plan.
  2. Basic Safe Harbor Match: The employer matches 100% of the first 3% of the employee’s contribution and 50% of the next 2%. Employees are required to contribute to their 401k with this particular contribution plan in order to get the match.
  3. Enhanced Safe Harbor Match: The employer matches 100% of the first 4% of each employee’s contribution. Similar to the Basic Safe Harbor Match, employees are required to contribute money to their 401k in order to qualify for the match.

As a business owner, you may need to have a holistic look at your business from the number of employees, individual salaries, and number of employees interested in contributing in order to determine the best contribution method for you and your business.

For example, the Non-Elective Safe Harbor plan may be the most cost-effective method, but if you have a larger number of employees who are not contributing to their plans, automatically supplying a 3% contribution to the employees may be more costly than offering the Basic or Enhanced Safe Harbor Matches.

Additional Safe Harbor 401k Guidelines

Aside from passing the IRS nondiscrimination tests and offering one of the contribution methods, businesses are required to provide their employees with written notice of their rights and the plan’s obligations at least 30 days prior (no more than 90 days) to the start of the plan year. Employers must also clearly define compensation and can access the IRS for in-depth language on the requirements.

Mid-year changes to your Safe Harbor 401k are permissible, but it should be noted that prior to a plan change, employees must be notified at least 30 days prior, but not more than 90 days, as to the changes going into effect. Employees must be allowed to change their cash or deferral election at least 30 days before the changes go into effect.

Deadlines for 2020 Safe Harbor 401k Plans

For business owners, the deadline for setting up their Safe Harbor 401k plan is August 23, 2020, making September 1, 2020 the deadline for notices to be sent to employees.

The latest the plans can go into effect and be exempt from 2019 nondiscrimination testing is October 1, 2020.

Is a Safe Harbor 401k Right for My Business?

Every business is constructed differently, and prior to initiating any programs and benefits for your employees, we recommend that you consult with a professional.

If you plan on matching the contributions or contributing to your employees’ retirement or are worried about one of the IRS nondiscrimination tests because you have low participation in retirement plans from your Non-Highly Compensated Employees, then a Safe Harbor 401k may be the right plan for you and your business.

It may be true that offering plans like a Safe Harbor 401k may add to your overall payroll and liabilities, but offering a Safe Harbor 401k may increase employee happiness, tax savings, and a business that will not fail any of the annual nondiscrimination tests.

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The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

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