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The Safe Harbor 401(k) - Class 203

Most 401(k) plans can be broken down into one of two categories: the Traditional 401(k) and the Safe Harbor 401(k). Last week’s class provided you with an overview of the Traditional 401(k) Plan. Today, we're diving deeper into your Safe Harbor options.

In order to determine whether the Safe Harbor 401(k) is right for you, we first have to weigh the pros and cons of this program. After that, we’ll review the different types of Safe Harbor plans so you can customize the program for your particular group of employees.

The #1 reason my clients opt for the Safe Harbor 401(k) is to avoid undergoing compliance testing each year. If your organization has Highly Compensated Employees (HCE’s are defined as employees who made over $130,000 the year prior to the current plan year) and business owners who wish to participate in the retirement plan, the Safe Harbor program could be the right fit for you. Since the Safe Harbor 401(k) allows participants to get an automatic pass on their salary deferrals, every employee is allowed to defer up to the annual employee contribution limits. For 2021, the contribution limit is $19,500 (and $26,000 for those participants over the age of 50). This program is also a good fit for organizations where the HCE’s and business owners are predicting to contribute the majority of the total participant contributions to the plan. Generally speaking, the safe harbor program allows you to pass your non-discrimination and top-heavy compliance tests. This is why most of my clients who have opted for the Safe Harbor 401(k) have selected this program.

Now, there are three primary reasons a plan sponsor may decide not to offer the Safe Harbor 401(k). The first reason is that the employer must make mandatory company contributions on behalf of the participants under this program. The second reason is that the service requirement for eligibility to participate in the plan must be the same eligibility requirement to receive these company contributions. The third mandate states that most Safe Harbor contributions must be immediately vested on behalf of the employee. Because many of my employers do not wish to offer company contributions within the plan or do not care for the restrictions in eligibility and vesting requirements, some plan sponsors decide not to offer a Safe Harbor 401(k) and opt for the Traditional 401(k).

If you are comfortable with offering the participants a company contribution, the above eligibility requirements, and immediate vesting of these Safe Harbor contributions, then you are most likely a fit for one of the Safe Harbor 401(k) Plans. If so, the last thing you must figure out is which of the Safe Harbor plans is the right fit for you. Here are the top Safe Harbor programs I speak to my clients about:

  • 4% SH Matching Plan
In my experience, this is the most popular of all of the Safe Harbor options. This plan says that the employer must offer a maximum contribution of 4% of the participants’ total compensation in the form of an employer match. The matching formula is a dollar-for-dollar match on the first 3% of the employees’ contributions and a fifty-cents-on-the-dollar match on the next 2%. If the employee defers more than 5% of their compensation, the employer is not required to match these contributions. Only employees who are contributing to the plan will receive the Safe Harbor matching contributions.
  • 3% SH NEC Plan
The 3% NEC Plan is slightly different than the 4% Matching Plan listed above in that the non-elective contribution (NEC) is made to all eligible employees. This means that regardless of whether the employee is actively contributing to the plan or not, that employee will receive 3% of their total compensation as a contribution into the plan as long as they are eligible to participate. Employers are allowed to extend eligibility as much as 12 months of service with the organization within all Safe Harbor plans.
  • QACA 3.4% SH Matching Plan
Although this is the least popular of the three Safe Harbor plans listed here, this plan could be right for your group of employees. Where the two above Safe Harbor plans are opt-in programs, this type of 401(k) is an opt-out program. Just like the 4% SH Matching Plan listed above, this program has a very specific matching schedule. Under the QACA SH Plan, the employer must offer a dollar-for-dollar match on the first 1% of the employees’ contributions and a fifty-cents-on-the-dollar match on the next 5% for a maximum employer contribution of 3.5%. One of the unique features of this SH Plan is that the employer has the ability to implement a 2-Year Vesting Schedule on these company contributions.

The last thing you should know is that if you currently sponsor a Traditional 401(k) Plan and you wish to transition to a Safe Harbor 401(k), there are some rules on when you can do so. You can transition to the Safe Harbor NEC Plan at any time as long as you provide the employees with 30-day’s notice. However, you can only transition to the Safe Harbor Matching Plans on January 1st of any given year. If you decide to do this, you must notify your current plan provider in time to generate the mandatory employee notification which must be circulated no later than December 1st of the year prior to the change (30-day’s notice).
Between last week’s class and today’s lesson, you should have everything you need to get a feel for whether the Traditional Plan or the Safe Harbor Plan is a better fit for your group of employees. Join us next week when we discuss Compliance Testing so you can understand how the Traditional 401(k) can potentially limit the benefit for you and your employees.

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