3 Reasons to Start a Safe Harbor 401(k) 

Author: Siân Killingsworth / 2 Nov 2022 / 401(k) Plan Information, Safe Harbor

While avoiding certain IRS non-discrimination testing is usually the main reason small businesses switch over to a Safe Harbor 401(k), these plans offer additional benefits to employers. Three reasons Safe Harbors are among the best 401(k) plans for small businesses include:

• Compliance
• Flexibility
• Attracting and retaining top talent

As a business owner, implementing a 401(k) plan is perhaps the most popular and effective way to ensure your employees are in a position to retire at a reasonable age.

However, the Internal Revenue Service requires employers who offer 401(k) plans to jump through several hoops, which can make it difficult for business owners (particularly owners of small businesses) to provide the benefit. One of the biggest obstacles in the way of offering a 401(k) plan is the IRS’s annual non-discrimination testing. During this test, the IRS checks to ensure that employers are not unfairly favoring certain employees. If a business fails this test, it can face severe punitive consequences.

As a result, many small businesses are better served by offering a Safe Harbor 401(k) plan, which makes them exempt from certain non-discrimination testing. These plans require mandatory employer contributions, as well as immediate vesting for employees.

#1. Helps Ensure Compliance

When a business offers a 401(k) plan, the IRS ensures the business does not unfairly favor highly-compensated employees (HCEs) through non-discrimination testing, performed annually. To do this, the IRS compares plan participation and contributions of every employee in the business, from entry-level employees to the owner.

According to the IRS, traditional 401(k) plans must follow these three rules to avoid failing the non-discrimination testing:

• HCEs cannot contribute greater than 2% of the average contribution of all other eligible employees. For example, if the average employee is contributing 4% of their income to the 401(k) plan, HCEs may not exceed 6%.
• HCEs cannot receive more than 2% in contributions compared to the average employee. For example, if the average employee is receiving 2% of their income in contributions to their 401(k) plan, HCEs may not exceed 4%.
• The combined assets of key employees’ (owners and officers) retirement accounts cannot exceed 60% of the employer’s entire 401(k) plan.

If a business’ plan fails these tests, it may be costly to correct. While larger businesses may have the ability to balance these requirements, it can be difficult for smaller businesses with limited manpower to stay in compliance.

A Safe Harbor 401(k) plan is designed to meet these requirements without any extra effort. And since Safe Harbor 401(k)s offer the same contribution maximums as traditional plans, HCEs can maximize their contributions without the plan failing the non-discrimination testing.

#2. Provides Flexibility

For small businesses, flexibility is one of the most important factors to consider when choosing a retirement plan. Safe Harbor 401(k) plans provide this flexibility with three different options:

• Basic Matching:

The Safe Harbor is a tiered match where the employer matches 100% of the contributions up to 3% of the employee’s compensation, and 50% of the employee’s deferrals up to the next 2% of compensation.

• Enhanced Matching:

If the business chooses an enhanced matching plan, it will match 100% of an employee’s contributions, up to a certain percentage of compensation (minimum of 4%).

• Nonelective Contributions:

Under a nonelective contribution plan, the employer contributes 3% of compensation to the employee’s 401(k) account, whether they choose to participate in the plan or not.

These percentages are minimums – if the business wishes to contribute more to its employee’s plans, they are free to do so.

#3. Helps Attract and Retain Talent

Another reason businesses choose to offer Safe Harbor 401(k) plans is to improve their ability to attract and retain top talent. In a competitive market, benefit plans allow employers to differentiate themselves from other employers. With a Safe Harbor 401(k) plan, employees are guaranteed an employer-contributed retirement account, which can greatly assist in the hiring process.

Moreover, top talent is more likely to be retained with a Safe Harbor 401(k) because the plans allow highly compensated employees to maximize their contributions without the fear of refunds or corrections that usually are associated with 401(k)s. Combined, these factors give small businesses a leg-up on their competition.

Contact Ubiquity for a free Safe Harbor consultation and learn how a Safe Harbor 401(k) can help your business.