Safe Harbor 401(k) Plans: Q & A 

Author: Siân Killingsworth / 28 Sep 2022 / 401(k) Plan Information, Safe Harbor

Small businesses have a myriad of retirement plan options. One is a Safe Harbor 401(k) plan, which reduces plan administration duties and frees you from annual IRS testing. While these time-saving incentives are undeniably attractive, it’s important for small business owners to consider how the Safe Harbor option stacks up against other small business retirement plans.

The following 401(k) questions and answers can help you determine whether a Safe Harbor plan provision is right for your small business.

What is a Safe Harbor 401(k)?

All qualified retirement plans are subject to certain nondiscrimination tests to verify that they do not provide unfair advantages to owners and highly compensated executives over other employees. Safe Harbor provisions enable immediate vesting of retirement benefits and allow the plan to bypass nondiscrimination tests.

These plans enable a type of contribution made by the employer into an employee’s 401(k) account. This amount is predetermined and normally represented as a percentage of the participant’s salary. The most common form of a Safe Harbor contribution is a match, meaning the employer is only responsible for contributing when the employee does so too.

What specific provisions are required for a plan to claim Safe Harbor protection?

Small business 401(k)s with Safe Harbor provisions generally include one of three employer contribution alternatives:

• The company matches 100% of an employee’s contributions up to 3% of the employee’s salary, with an option of an additional 2% match for half the salary.
• The company matches 100% of an employee’s contributions up to 4% of the employee’s salary, with no option for additional employer contributions.
• The company contributes an amount equal to 3% of the employee’s salary with no contributions by the employee.

How does a small business implement a Safe Harbor 401(k) plan?

If a small business wants to include Safe Harbor provisions in a retirement plan, it must provide prior written notice of those provisions to all employees. That notice must specify the Safe Harbor provisions that the small business has elected to adopt, as well as detailed information on the provisions’ effects on taxation and employee rights. The small business must also factor contributions and plan administration costs into its accounting systems.

How do small businesses benefit from Safe Harbor 401(k) plans?

First, when an employer has a Safe Harbor feature in their 401(k) plan, the most critical advantage is that they are automatically exempted from the annual compliance testing that’s required for all non-Safe Harbor 401(k) plans. This testing is essentially a government-mandated review of the plan whose purpose is to ensure that the 401(k) plan itself isn’t overly advantageous to highly compensated employees (HCEs) at the company.

A highly compensated employee is generally someone who owns or has owned more than 5% of the interest in the business any time during the year or preceding year. Another definition of an HCE is one who made more than $135,000 in the previous year in their income.

A key point to know for testing season is if the 401(k) plan doesn’t have a safe harbor, and it goes through that annual testing, and those test results find that a given HCE’s contributions for the year exceeded 2% of the average contribution rate of all non-HCEs, then that HCE who over-contributed will have to take a mandatory distribution from their account. By extension, this money will no longer be accruing in their retirement accounts.

How do Qualified Automatic Contribution Arrangements (QACAs) affect a Safe Harbor 401(k) plan?

QACAs are a subset of Safe Harbor 401(k)s that include automatic enrollment provisions. With a QACA option, the small business is obligated to make matching contributions to employee retirement plan accounts. The primary QACA benefit is that it allows a small business to implement a two-year vesting schedule for employer matching contributions.

More Safe Harbor 401(k) Questions? Ask Ubiquity

If you have questions about 401(k) retirement plans for your small business, including how to take advantage of Safe Harbor tax credits, contact Ubiquity — one of America’s top providers of low-cost, flat-fee small business 401(k)s.