An issue that goes hand in hand with the topic of 401Ks is fairness. In order to ensure that your company isn’t prioritizing benefits for HCEs (highly compensated employees) and discriminating against lower income employees, the IRS conducts annual compliance tests. This process consists of three tests: The ADP Test (Actual Deferral Percentage), The ACP Test (Actual Contribution Percentage), and The Top Heavy Test.
The Safe Harbor 401k Plan was developed to ensure that businesses are following the IRS guidelines in maintaining compliance with the requirements for fairness and non-discrimination in 401K plans.
What Is a Safe Harbor 401K Plan?
A Safe Harbor Plan 401K Plan ensures that businesses pass the three IRS compliance tests given annually. Generally, this is accomplished by instituting one of three contribution options:
- Basic Matching. In the Basic Matching option, the employer matches 100% of every employee’s contribution to their 401k plan (up to 3% of employee’s annual compensation, while meeting an additional 50% of the next 2% of his or her deferrals).
- Enhanced Matching. With this option, the company will match 100% or more of each of its employee’s 401k contributions (up to 4% of employee’s compensation).
- Non-Elective Contribution. This option is defined by the company contributing 3% or less of each employee’s compensation to all 401k participants without regard to employees’ contribution.
In a 401k, the employer has to contribute to employees’ plans. In turn, these contributions are tax deductible for the business. By instituting one of the above options in a Safe Harbor Plan, the contributions made by the employer to the employees’ plans are vested immediately. This allows employers to stress less during tax time, knowing that they won’t be caught with heavy fines due to being out of compliance.
Can I Still Set Up a Safe Harbor Plan for My Business This Year?
In general, Safe Harbor plans must be in place for three or more months if the company is starting a new 401k plan. Therefore, if you plan to institute Safe Harbor provisions for the year 2021, it needs to be done by October 1, 2021 or sooner.
For companies that wish to add a safe harbor provision to an existing 401k plan, employers are required to provide a 30-day notice to employees. Therefore, if your plan year begins at the beginning of the calendar year, on January 1st of 2022, you’ll need to request the Safe Harbor provision prior to November 30th, 2021.
On average, smaller businesses will benefit more than larger companies in implementing a Safe Harbor provision. However, every business is going to be different. The best choice for your business is going to be determined by a variety of factors including number of employees and your goals for the business. It is important that you weigh the risks and fully understand the benefits and downsides to implementing a Safe Harbor provision in your company’s 401k plan, before you do so. A financial professional can help you navigate these issues and determine what course will be best for your business.