For companies looking to provide their employees with the tax benefits as a regular 401(k) plan without all the hassle, setting up a safe harbor 401(k) means they can skip the onerous annual testing requirements and expenses associated with nondiscrimination tests typically required for a traditional 401(k).
In this article, we discuss the problems a safe harbor 401(k) can solve for companies and outline how the plan can be set up.
What is a safe harbor 401(k) trying to solve?
Before you ask what a safe harbor 401(k) is, you should understand a bit more about why someone would want one. Most 401(k) plans face an annual non-discrimination test where the IRS checks to see if highly compensated employees or business owners are maxing out 401(k) contributions for the year, while the rest of the employees lag in their savings. The IRS wants to see that all employees are taking advantage of the retirement plan, not just those with high-paying jobs.
If you’re a business owner and your 401(k) plan has low participation or saving rates among rank-and-file employees, it may raise a flag for the IRS.
What is a safe harbor 401(k)?
A safe harbor 401(k) is a plan structure that either automatically passes the non-discrimination test or avoids it altogether. It’s relatively easy to do, but the employer must make contributions to each employee’s plan—the same percentage of compensation for everyone. For example, for every contribution made by an employee, the company adds another 5% of their salary. The amount you match will depend on your own contributions as a business owner.
What’s the difference between a safe harbor 401(k) plan and a traditional 401(k) plan?
A safe harbor 401(k) plan is similar to a traditional 401(k) plan, but one of the key differences is that it must provide for employer contributions that are fully vested when made. Unlike a traditional 401(k) plan, the safe harbor 401(k) plan is not subject to complex annual nondiscrimination tests.
Employer notice requirements
Safe harbor 401(k) plans are the most popular plan type established by small businesses, but companies that want to offer 401(k) savings plans to their employees must ensure they don’t run afoul of complicated government rules. For example, employers sponsoring safe harbor 401(k) plans must satisfy certain notice requirements and the initial plan year must begin at least three months in advance.
The notice requirements will only be satisfied if:
- Every eligible employee for the plan year is given written notice of the employee’s rights
- Obligations under the plan and the notice satisfies the content and timing requirements
Content requirement
In order to satisfy the content requirement, the notice must describe:
- The safe harbor method employed
- How eligible employees can make elections
- Any other plans involved
Timing requirement
The employer must provide notice to each eligible employee within a reasonable period before each plan year—at least 30 days and not more than 90 days before the beginning of each plan year.
Main Takeaways
- An employer can choose to match only those employees that personally participate in the plan (you do not give money to employees unwilling to put in some of their own funds).
- Contributions can be tax deductible for both the employer and employee, and savings can grow tax-free.
- Starting a retirement savings plan can be easier than most business owners think.
- Even self-employed individuals can establish a plan!
If you’re looking to roll out a retirement plan for your employees, a safe harbor 401(k) can simplify the process—if you’re willing to follow certain rules. As always, the team at Financial Solution Advisors is only a phone call or email away. Please let us know if you have any questions or would like any additional information!