Introducing Safe Harbor
There is a way to build a 401(k) plan and avoid many annual compliance tests. It’s called the Safe Harbor program. This type of plan automatically meets the nondiscrimination rules described earlier. Therefore, ADP and ACP tests do not apply, and the amount HCE can contribute to the program is not limited by other labor contributions.
Safe Harbor plans are also exempt from the top-heavy test, unless employer-provided contributions are not required safe harbor matching or non-selective contributions as described in the next section. For example, in the case of profit sharing contributions, a top-heavy test may be required. If testing indicates that the program is top-heavy, the employer may be required to make additional contributions to the program.
In exchange for waiving most testing and other administrative burdens, employers who choose a Safe Harbor 401(k) must pay annual fees on behalf of their employees and choose to comply with other requirements based on their 401(k) design.
Safe Harbor 401(k) Design Options
A Safe Harbor 401(k) can be designed in two ways—a traditional Safe Harbor 401(k) and a Qualified Automatic Contribution Arrangement (QACA). Both avoid the need for testing and require employers to contribute to participants. However, some important differences are listed in the table.
Traditional Safe Harbor 401(k) and Qualified Automatic Payment Arrangement (QACA)
|Traditional Safe Harbor 401(k)||Qualified Automatic Contribution Arrangement (ACA)|
|register||Employees can participate in the program themselves, or you can do it for them. Either way, you must contribute to the program according to one of the formulas below.||Unless the employee chooses not to participate, you must automatically enroll eligible employees into the plan and deduct at least 3% of wages for enrollment into the plan.
For each subsequent year, employee contributions are automatically increased by at least 1% until at least 6%, but the plan can cap these automatic increases up to 15%.
Additionally, you must contribute to the plan according to one of the formulas below.
Employers pay 100% of their employees to the program for the first 3% of wages plus 50% of the next 2% they pay.
Employers will match 100% of the employee’s first 1% of wages paid for the program and pay an additional 50% on the next 5%.
|fortress||Safe Harbor contributions—whether matched or non-selective—are always fully vested.||Safe Harbor contributions—whether matched or non-selective—must be fully vested once an employee completes two years of service.|
Which safe harbor design is right for your company?
When choosing between a traditional safe harbor 401(k) and QACA, consider the following important questions:
- Instant Bastion or Delayed Bastion?
With a traditional safe harbor 401(k), employer contributions vest fully as they are made. However, with QACA, these contributions may be subject to a two-year vesting schedule. Employees who leave their jobs before the second anniversary of their employment will have the amount in their employer’s contribution account forfeited. Forfeited funds can be used to offset required employer contributions in future years.
- Auto-enrollment or opt-in?
Automatically enrolling employees in a 401(k) has proven to be an effective way to help employees build retirement savings. Auto-enrollment is optional in traditional safe harbor designs, but required for QACA.
- Matching or non-selective contributions?
With the non-selective contribution option, all eligible employees, including those who do not contribute to the plan, contribute 3%. With the matching contribution option, contributions are only available to employees who contribute themselves. Since the basic matching formulas of traditional Safe Harbor 401(k) and QACA are different, your potential cost will depend on the number of contributing employees and their contribution rate.
For example, if you choose the traditional safe harbor design and all eligible employees contribute 5% or more of their salary, your matching cost will be 4% of the payroll. However, in a typical plan, some employees opt out or choose to contribute less than 5%, so your costs will typically be less than 4%.
On the other hand, if you choose the QACA design and all eligible employees contribute 6% or more of salary, your matching cost will be 3.5% of the payroll.
Safe Harbor 401(k) Deadline
If you’re considering a safe harbor 401(k), here are some important deadlines you need to know:
- new plan — During the first year of the program, employees must have the opportunity to contribute for at least three months. Therefore, for a 401(k) plan to run during a calendar year (like most plans), the plan must be in effect by October 1.
If you choose a QACA design or will make matching contributions, you must give employees at least 30 but no more than 90 days’ notice before the plan’s effective date. For each subsequent year, the notice must be filed between October 1 and December 1.
- existing plan — You can modify an existing standard 401(k) to add a safe harbor feature. If you will be making a non-selective 3% contribution, you can amend the plan on November 30 of that calendar year to add this feature.
A recent legal change allows you to wait until the end of the following year if you will be making non-selective contributions of 4% instead of 3%. Programs can only be modified to add safe harbor competitions at the beginning of the calendar year. In this case, employees must be notified at least 30 days in advance at the beginning of the year.
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