Safe Harbor 401(k) plans can benefit certain business owners significantly. This article aims to inform you what kind of benefits they provide and whether or not they are a good fit for your business.
Safe Harbor 401(k) plans are when the employer makes certain contribution obligations so the owners don’t have to do non-discrimination testing. They can only skip testing if certain IRS requirements are met.
How Do Safe Harbor Plans Work
When you start a Safe Harbor 401(k) plan you are committed to the plan for the whole year. Each year, you need to make the mandatory contributions. There are two types of contributions in a Safe Harbor plan.
The first type of contribution is a match. The employee has to contribute (defer) 5% or more from their wages in order for the employer to make a 4% match. This contribution is limited to employees who defer money to the plan. If an employee doesn’t defer they won’t get the Safe Harbor match.
The formula for the matching contribution that the IRS wants us to use is 100% of the first 3%, and 50% of the next 2%.
The second type of contribution is a 3% non-elective where the 3% goes to all eligible employees. This 3% Safe Harbor also goes to the employee whether they are contributing (deferring) to the plan or not.
With both types of contributions, the plan does not need to go through non-discrimination testing. But only if it meets the requirements set by the IRS. Those requirements include the following:
- Notice requirement – IRS requires that each eligible employee is provided with written rights and obligations under the plan that meets content and timing requirements.
- Content requirement – To satisfy the notice requirement, the content must provide information on how the plan is used. Meaning how eligible employees make elections and what other plans are in use. See the IRS site for more content requirements.
- Timing Requirement – In order to fulfill this requirement, each eligible employee must be provided with the notice at least 30 days or no more than 90 days before the beginning of each plan year.
There are some downsides to Safe Harbor plans. You should be aware of these downsides as a business owner or financial professional before starting a plan.
- Safe Harbor plans are a year-long commitment. You need to be able to meet the minimum contributions for the whole plan year. If you are unable to meet this requirement there will still be required contributions and probable non-discrimination testing failures.
- Company contributions are immediately 100% vested. This means the employee can take the money with them if they leave the company. They can then decide to roll it over into another plan after they have left.
- The last downside is that you can not have an hour- or last-day requirement for Safe Harbor contributions like a regular employer contribution to a 401(k) plan. So even if someone that is eligible leaves on January third, they will still get a contribution for that short time.
Are these downsides a deal breaker? Probably not, but it depends on your situation. These are just 3 possible downsides to keep in mind when you’re deciding on whether or not you want to start a plan.
Example Company for a Safe Harbor Plan
What type of business would a Safe Harbor 401(k) plan work best with? There are 2 ends of the spectrum and it mostly depends on who the owner is and who the employees are.
On one end of the spectrum, you have a business that has mostly minimum wage staff or staff that aren’t likely to defer to the plan. In this situation, the business owner can start a Safe Harbor plan in order to get the maximum contribution for themselves. The employer will also get the SH match for themselves. Only employees who defer will get their share of the SH match.
On the other end of the spectrum, you have a business where the owner wants to maximize their own contributions each and every year. The 3% SH 401(k) plan is usually the most cost-effective way to do that while still providing your employees with a contribution. So if you’re an owner who wants to retire sooner, this plan could be a great option.
How Do You Start A Safe Harbor Plan?
The easiest way to start this plan is with a third-party administrator like us! Just go to our signup page and get in contact with our sales team to ask any questions you may have. We are happy to help.