What is a Safe Harbor 401(k) Plan?

Offering a retirement savings plan to employees can help companies attract and keep top talent. But with many types of 401(k)s available, including traditional, after-tax Roth, safe harbor, or SIMPLE 401(k)s, choosing which plan to offer can be difficult for business owners.

Various factors must be considered to ensure compliance with all IRS regulations, including engagement rates, company size, and compliance or nondiscrimination testing capabilities.

For employees, working for a business that offers employer-matching contributions in their retirement savings plan can be a plus. These contributions may help accelerate savings and investment growth, especially if employees receive them earlier on in their respective careers.

Finding a plan that works for employers and employees is essential. Here, we will explore one 401(k) option, the safe harbor plan. We will dive into what it is, how it works, what you need to consider, and all its benefits.

What Is a Safe Harbor 401(k) Plan?

A safe harbor 401(k) plan is a retirement savings plan that allows employers to forego certain IRS tests if basic guidelines around matching contributions, vesting, and employee notification are met.

When a business offers a traditional 401(k) plan, it must perform annual testing to ensure it meets the nondiscrimination requirements outlined by the IRS. These compliance tests are in place to ensure that a company meets those requirements and that their employee contributions do not discriminate to favor highly compensated employees.

But with a safe harbor 401(k) plan, employers can bypass some of these IRS nondiscrimination tests by offering fixed contributions to eligible employees — a step that ensures their retirement plan is fair. Like any 401(k), a safe harbor match is designed to help employees save for retirement.

These employer contributions are set at fixed levels to meet IRS regulations and help employers avoid the headache of performing top-heavy testing every calendar year. Those testing processes can be complex and time-consuming, so it’s no wonder the safe harbor 401(k) is appealing to employers.

Safe Harbor Retirement Plan Requirements

A safe harbor 401(k) is designed to include safe harbor contributions, and since it offers employers a way to avoid annual nondiscrimination testing, some requirements apply:

• Contributions: Companies must make mandatory contributions to each participant through a matching or non-elective contribution. There are three contribution methods: basic match, enhanced match, or non-elective match.
• Vesting: These safe harbor contributions must be considered immediately vested — or secured by the employee — even if the employee separates from the employer.

• Timing restrictions: For companies starting new 401(k) plans, there are requirements around timing that will determine what kind of safe harbor options are available within the first plan year. The IRS outlines this timeline so that businesses can establish a compliant plan design.
• Notification: Employers must notify their employees about safe harbor provisions 30 to 90 days prior to the start of a plan year. This notice must also be provided to newly eligible employees.

Safe harbor plans, when established correctly, can help employers avoid nondiscrimination testing and ensure compliance with ADP (Actual Deferral Percentage), ACP (Actual Contribution Percentage), and contribution limit regulations for 401(k) retirement savings plans.

Top Benefits of a Safe Harbor Plan

Safe harbor plans can benefit a company’s business owners and employees. Employees can increase their overall compensation by maximizing elective deferrals and benefitting from employer-match contributions.

There are many benefits of a safe harbor 401(k), including the following:

• Allows all employees a tax-advantaged way to save for retirement: Like other 401(k) plans, employees can contribute up to the IRS contribution limit (in 2023, that limit is $22,500 for employees under age 50, and $30,000 for those over 50).
• Employer contribution benefit: Because of the mandatory contribution percentage from the employer, a safe harbor 401(k) ensures a reasonable bump to employee compensation — and to retirement savings.
• Small business tax credits: Small businesses with up to 50 employees can get tax credits that cover start-up costs for safe harbor plans.
• Satisfies top-heavy testing: These plans ensure that companies are not favoring key employees and will automatically pass ADP and ACP safe harbor tests.

The Safe Harbor Contribution Formulas

As mentioned above, a company must follow one of the three safe harbor 401(k) contribution formulas to be considered a legally operating safe harbor plan. These options are tax-deductible for small business owners and will ensure compliance with IRS testing requirements.

The three types of match formula options are:

1. Basic Match: In this setup, the company matches 100% of the first 3% of the employee’s deferred compensation in addition to another 50% match on the next 2% of deferred compensation.
2. Enhanced Match: This option requires companies to match at least the amount of basic match at any level of employee deferral. One standard option is a 100% match on the first 4% of deferred compensation.
3. Non-elective safe harbor contribution: With this setup, the company contributes at least 3% of each employee’s compensation, even if the employee has not elected a 401(k) deferral percentage on their own.

Unlike traditional 401(k) plans, within a safe harbor plan, the employer’s contribution must be immediately 100% vested.

The details of the match formula will be outlined in a company’s summary plan document and determined by the plan sponsor in collaboration with the business owner.

Understanding QACAs

Since safe harbor 401(k)s are intended to ensure that all employees—not only those who are highly compensated—benefit from retirement savings, some implement QACAs, or Qualified Automatic Contribution Arrangements.

This guideline is an automatic enrollment feature that can be included in all safe harbor retirement plans. A QACA may stipulate that any employee who doesn’t elect a contribution amount will be automatically enrolled in the default minimum contribution outlined by that given safe harbor plan.

Although safe harbor 401(k) plans must be immediately 100% vested, a QACA plan can opt for a vesting schedule spanning up to two years.

Employees can opt out of their 401(k) plans if they wish, but QACAs are ultimately in place to help people save for retirement. The idea behind QACAs was to make it as easy as possible for employees to build retirement savings, and research shows that QACAs tend to boost participation rates overall.

Safe Harbor 401(k) Contribution Limits

All retirement savings accounts have contribution limits outlined by the IRS. Unlike profit-sharing plans, to which only employees may contribute, 401(k) plans allow employees to contribute money themselves.

With safe harbor 401(k) plans, the annual limits are the same as traditional 401(k)s for 2023:

• For employees under 50, the maximum contribution is $22,500.
• For employees 50 and over, the maximum contribution is $30,000.

Safe harbor provisions allow employers, highly compensated employees, and non-highly compensated employees to make the most of their discretionary salary deferrals and distributions without nondiscrimination testing hassles each year.

The Bottom Line

A safe harbor 401(k)is a retirement savings plan that helps both employers and employees. Employers can benefit from avoiding nondiscrimination testing on an annual basis, while employees can enjoy at least reasonable employer contributions that can help accelerate retirement savings.

When managing your retirement funds, working with a trusted partner (like a financial advisor) who can provide guidance and ensure you meet all regulatory guidelines is essential.

Capitalize is here to help you manage your 401(k) rollovers and make financial decisions to build a solid financial future.

Explore how we can help you and your employees with your retirement savings goals.