Benefits of a Safe Harbor Provisioned 401(k) Plan

Author: Robby Forsythe / Reviewer: Callie Adams Farnsworth, QKA, CAFCA
5 Apr 2023 / 401(k) Plan Information, Safe Harbor, Small Business 401k

If you are a small business owner, you may have considered offering your employees a 401(k) plan to help them save for their future (and reduce their taxable income in the process).

However, setting up and maintaining a 401(k) plan can be complex, and failure to comply with the regulations could result in corrections and even have large penalties. One way to make the process easier (and safer) is by offering a Safe Harbor 401(k) plan.

What is Safe Harbor?

Although most people refer to this as a Safe Harbor plan, Safe Harbor is actually just an optional provision to a 401(k) plan. This provision is designed to automatically pass certain nondiscrimination testing requirements set by the IRS. These requirements ensure that the plan does not favor highly compensated employees over non-highly compensated employees when it comes to contributions and benefits.

With a Safe Harbor provision in your 401(k) plan, you agree to make certain contributions on your employees’ behalf; in return, the plan is exempt from certain non-discrimination testing requirements.

The Benefits of a Safe Harbor 401(k) Plan

Reduced Administrative Burden

One of the main benefits of offering a Safe Harbor 401(k) plan at your small business is that it can greatly reduce the administrative burden on you as the employer. Non-Safe Harbor plans require annual deferral and match testing, which can be complex and time-consuming.

With a Safe Harbor plan, those testing requirements are waived, allowing the employer to spend less time and resources on plan administration.

Increased Employee Participation

Another advantage of a Safe Harbor 401(k) plan is that it can increase employee participation. By offering a safe, simple, and automatic plan, employees are more likely to enroll and contribute to the plan. This can help employees save for their future while also helping you attract and retain top talent.

Avoiding Corrections

Non-compliance with non-discrimination testing can result in corrections, which could mean you have to return contributions to highly compensated employees and pay taxes and penalties. Safe harbor plans are exempt.

Higher Contribution Limits Annually

All 401(k) plans, including those with a Safe Harbor provision, have higher contribution limits each year per the IRS. In 2023, employees can contribute up to $22,500 to their 401(k) plan, with an additional $7,500 catch-up contribution for those over age 50. This can help employees save more for their retirement. While the increased limit isn’t unique to Safe Harbor plans, it’s certainly a nice expansion of the benefit. A Safe Harbor provision does allow highly compensated employees to contribute up to the limits without worry of any corrective refunds.

How to Set Up a Safe Harbor 401(k) Plan

If you are interested in setting up a Safe Harbor 401(k) plan for your small business, there are a few things you need to know.

Contribution Types

To be eligible for a Safe Harbor 401(k) plan, you as the employer must make certain contributions to your employees’ retirement accounts. There are two types of Safe Harbor contributions: a non-elective contribution or a matching contribution.

• The non-elective contribution requires employers to contribute a percentage of each eligible employee’s compensation, regardless of whether the employee contributes to the plan.
• The matching contribution requires the employer to match 100% of each eligible employee’s contributions up to a certain percentage (usually 4%) of their compensation.

Funding Requirements

To maintain Safe Harbor status, employers must make the required contributions on time each year. Both contribution types must be funded by the end of the next plan year and generally, to take as a deduction, they must fund prior to their tax return including extensions. However, some documents require that the match be funded each pay period, which means they are required to fund no less than a quarterly basis to avoid late penalties.

Notice Requirements

To offer a small business 401(k) plan with a Safe Harbor provision, you must also provide certain information to employees. This includes notification explaining the plan’s provisions and informing employees of their right to make contributions to the plan. This notice must be provided at least 30 days before the beginning of each plan year.