Ubiquity Retirement + Savings has been an affordable provider of retirement solutions, including Safe Harbor 401(k) plans, designed for small businesses, start-ups, and solopreneurs since 1999.
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Many small business owners find that the good outweighs the bad with a Safe Harbor 401(k) plan, which gives them a free pass on annual IRS testing.
In exchange for bypassing the usual nondiscrimination tests, Safe Harbor plans require employers to make annual contributions on behalf of their employees. If you were going to contribute to employee plans anyway, then there is nothing to lose and much to gain with a Safe Harbor 401(k). Not all small businesses are likely to fail nondiscrimination tests, however, so you may find that the Traditional 401(k) is a less expensive option.
Let’s face it: no one loves a test – especially when IRS penalties are involved. Other types of 401(k) plans have to pass three tests:
This limits the percentage of compensation that Highly Compensated Employees can defer into their 401(k) based on the average contribution rates of non-highly-compensated employees. This test can easily impact small business plans, particularly when there are not many non-HCEs.
This test ensures that the employer matching contributions and any after-tax employee contributions for HCEs are not disproportionately higher compared to non-highly-paid employees.
This test ensures that key employees cumulatively hold less than 60% of the total plan balance. Key employees are defined based on ownership status, officer status, and compensation.
Is it an added headache and expense to pay for annual auditing? Yes. Is it a challenge for small businesses to pass these tests every year? It can be. If you fail the test, the IRS will give you specific instructions on how to remedy the situation. This could mean refunding some of the contributions back to HCEs or putting more money into non-HCE accounts, not to mention a 10% penalty.
Failures can be time-consuming and expensive to correct, which is why many businesses avoid the uncertainty altogether by opting for a Safe Harbor 401(k).
Once you’ve decided that a Safe Harbor 401(k) is the way to go, you have a few different options to weigh.
With the Basic formula, you provide a 100% “dollar for dollar” match on the first 3% of compensation contributed by employees, plus a 50% match on the next 2% contributed.
With the Enhanced formula, you provide a 100% “dollar for dollar” match on contributions from 4-6% of compensation contributed by employees.
With the Non-Elective formula, you commit to a mandatory contribution of at least 3% of total compensation for all employees that meet the plan’s eligibility rules, regardless of whether or not they contribute to the plan.
You should consider a Safe Harbor plan for your small business if you want to take care of your employees as a matter of good business principles or if you want to adopt a match program that is truly competitive. Maybe you’ve had a plan that has failed nondiscrimination testing in the past and you’d rather bypass the whole ordeal, or you currently have a low retirement savings participation rate you’d like to boost. Contact Ubiquity to learn more about the Safe Harbor 401(k), as well as alternatives like traditional 401(k) plans and Solo 401(k)s. If you have an existing plan, you can add a Safe Harbor provision by contacting us, too.