Why Is Safe Harbor Best for Small Businesses?

Retirement benefits are increasingly attractive to prospective employees. A study by Accenture found that 68% of workers worldwide ask whether a company has a retirement savings plan, and 62% say it affects whether they’ll accept a job offer or not. Small business owners can use a Safe Harbor 401(k) plan to attract and retain top talent, saving money on attrition and enjoying the productivity gains.

While 401(k) plans are a great benefit, they’re not exactly easy to run. The IRS requires business owners to make retirement savings available to all eligible employees and not just for the benefit of a handful of key employees. To ensure fairness, they mandate annual auditing and compliance testing, which can be a time-consuming hassle for employers.

If a plan fails the actual deferral percentage, actual contribution percentage, and top-heavy tests, money may need to be refunded to Highly Compensated Employees or added to Non-Highly Compensated Employee accounts. If failure becomes a habitual pattern, the plan may be terminated altogether.

Small businesses, in particular, are vulnerable to failing these tests because business owners generally want to maximize their contributions and end up having a larger percentage of plan assets.

For this reason, employers with 100 workers or less often choose a Safe Harbor 401(k) over a Traditional 401(k) because it essentially functions the same but allows them to avoid the ongoing difficulty and expense of annual compliance testing.

A Safe Harbor 401(k) offers a quid pro quo exchange, where employers agree to make generous contributions to all eligible employee accounts in exchange for the safe harbor from certain IRS testing requirements. Employers may choose one of several formulas:

• A basic match:

  Contributing a 100% match for all employee contributions up to 3% of their salaries, plus a 50% match of the next 2% of their salaries.

• The enhanced match:

  Contributing 100% match for all employee contributions up to 6% of their salaries.

• A non-elective contribution:

  Contributing at least 3% of each employee’s salary to a 401(k) account, regardless of whether the employee contributes themselves.

In 2024, individuals can put up to $23,000 into a tax-free 401(k) retirement savings account. Those 50 and older can put in an additional $7,500 catchup contribution. The self-employed may contribute to their own accounts as both employer and employee, setting aside a maximum of $69,000. Spouses may also qualify to contribute, so if a business owner files jointly, the household may reduce their taxable income for the year by up to $138,000 (if they’re under 50) or $153,000 (if they’re 50 or older). That’s a considerable retirement nest egg, especially when one considers compounding interest and growth.

Business owners who contribute a hefty portion of their own salary to a personal 401(k) account can find themselves in a lower tax bracket, which reduces their overall tax liability.

Furthermore, employers can also deduct all matching contributions made to employee accounts – up to 25% of eligible compensation(the corporate deduction limit). Any additional profit-sharing contributions are also deductible, further reducing the tax strain on small businesses.

The SECURE Act enhanced business tax credits are available for businesses setting up first-time 401(k) plans. This includes starting or switching to a new Safe Harbor plan. Employers can:

• Save up to $15,000:

  Small businesses with up to 100 employees can earn tax credits worth $250 per Non-Highly Compensated Employee to a maximum of $5,000/year, for the first three years of the plan. (Highly Compensated Employees earn more than $130,000 in 2021-2022).

• Save up to $1,500 more:

  Small businesses can earn an additional tax credit (worth $500/year for three years) by adding automatic enrollment as a feature. (Employees can still opt out of auto-enrollment if they choose.)

Ubiquity is a Safe Harbor 401(k) administrator that can help small businesses get the most out of their retirement savings plan. The Safe Harbor provision is a great idea for any small business employer who wants to:

• Maximize retirement savings
• Take care of employees with contributions
• Save on taxes
• Improve rank-and-file participation
• Avoid failing nondiscrimination tests

There are a few upcoming deadlines to be mindful of:

• 9/23/22 –Deadline to contact Ubiquity to set up your Safe Harbor 401(k) plan
• 10/1/22 – Deadline for starting a Safe Harbor 401(k) plan applicable to the 2020 tax year.
• 11/15/22 – Deadline to request a Safe Harbor provision for existing Ubiquity 401(k) plans in 2022.
• 1/1/23 – Safe Harbor provision takes effect and exempts an existing plan from testing in 2022.

If you’re interested in this type of plan, you may contact us for a free Safe Harbor consultation. We also offer traditional small business 401(k)s if you decide the Safe Harbor isn’t for you. With a Traditional 401(k), employers are not required to match or contribute to employee accounts.

Ubiquity provides easy plan setup and administration at a flat, low monthly fee that remains the same, regardless of plan size. We are dedicated to customizing a retirement savings plan that meets your retirement goals. Contact us today and see how simple and affordable it can be to create a more secure financial future for you and your employees.