WHAT IS SAFE HARBOR 401(K) PLAN?

The safe harbor 401(k) plan is one of the most popular plan designs for small employers.

The beauty of the safe harbor plan is that for the price of a safe harbor employer contribution, the discrimination tests that apply to employee deferrals (ADP) and matching contributions (ACP) are deemed satisfied and, thus, the Highly Compensated Employees (HCEs) may make the maximum allowable deferral of compensation without the need for the plan to pass the discrimination tests.

However, employers need to be aware that all safe harbor contributions are immediately 100% vested and that all eligible employees must receive a safe harbor contribution, even if they do not work 1,000 hours or are not employed on the last day of the plan year.

However, employers need to be aware that all safe harbor contributions are immediately 100% vested and that all eligible employees must receive a safe harbor contribution, even if they do not work 1,000 hours or are not employed on the last day of the plan year.

The Safe-Harbor 401(k) Nonelective Contribution – Guaranteed or Flexible Option

An employer may satisfy the safe-harbor by making a Nonelective Contribution (NEC) of at least 3% or more of compensation (commonly known as the “3% NEC”). Generally, the 3% NEC must be provided to all employees eligible to make elective deferrals to the plan. The NEC may be either a guaranteed contribution or a flexible contribution. The employer will make this selection in the plan document. The guaranteed contribution requires that a NEC be made each plan year, unless the employer amends the plan and removes the provision before the start of the new plan year. The flexible NEC allows the employer to decide each year whether to provide a NEC contribution. If this option is selected, the employer provides a “conditional notice” 30 to 90 days before the start of the plan year in which the employer may give a safe-harbor NEC contribution. No later than the first day of the 12th month of that plan year, the employer must provide another notice indicating whether the safe-harbor status has been elected and thus if the NEC is being given. If the NEC is made, discrimination testing of elective deferrals (and matching contributions) is not required; if the NEC is not given, elective deferral contributions (and matching contributions) must be tested.
 
The Matching Contribution – Basic or Enhanced Match Formula

The alternative safe-harbor contribution is an employer matching contribution. There are two options, the basic or the enhanced match.
 
The basic safe-harbor matching contribution is defined as a 100% match on the first 3% of compensation deferred and a 50% match on deferrals between 3% and 5%.
 
Alternatively, the employer may choose an enhanced matching formula equal to at least the amount of the basic match; for example, 100% of the first 4% deferred. The enhanced matching contribution rate may not increase as the percentage of deferrals goes up, and the rate of match for the HCE group may not exceed the rate of match for the nonhighly compensated employee group (NHCEs).
 
The type of safe-harbor matching contribution selected (basic or enhanced) must be described in the plan document and in the annual notice to eligible participants. Unlike the nonelective contribution, there is no flex matching contribution option.
 
Further, there are some requirements that must be met for a plan to attain safe-harbor status. The plan document must be amended to add the applicable safe harbor formula, and a safe harbor notice must be given to all eligible employees between 30 and 90 days before the beginning of plan year. Failure to give this notice will result in the employer being unable to claim safe harbor status for the affected plan year, yet still required to make the safe harbor contribution (in addition to any contribution formula other than the conditional NEC has been adopted). The IRS has announced that merely not providing the notice on a timely basis does not remove the contribution requirement.