SH101: Safe Harbor 401(k), Back to Basics

Successfully Communicate Key Points to Decision-makers
August marks the beginning of a busy retirement plan selling season; during this time, many businesses establish new plans and evaluate changes to their existing retirement programs. The last five months of the year are punctuated by a number of important new plan milestones or deadlines. The first milestone is October 1, the last day to establish a new Safe Harbor 401(k) plan for calendar-year businesses. Safe Harbor feature is among key provisions of most small to mid-size 401(k) plans, so it is helpful to understand how it works and what benefits it offers. Let’s review some of the Safe Harbor 401(k) basics.
What It Is
In order to retain their tax advantages, 401(k) plans have to pass non-discrimination testing. These tests compare salary deferral and matching contribution amounts allocated to highly compensated employees (HCEs) and non-highly compensated employees (NHCEs). If the ratios fall within the parameters specified by the Internal Revenue Code, the plan is deemed to satisfy these tests. When the ratios are out of line, the tests fail. To remedy the failures, plans have a few prescribed methods, which include refunding some (and sometimes all) of the deferrals made by the HCEs, and/or making a special fully vested contribution to the NHCE participants.
In this case, a special safe harbor contribution makes a significant difference, often a deciding factor in making a 401(k) plan viable for a business. A 401(k) plan that includes a safe harbor provision will satisfy these tests automatically. As a result, highly compensated employees are able to maximize their deferrals regardless of deferral behavior of the rank-and-file participants. The tests will pass even if the rank-and-file participants do not make any salary deferral contributions.
How it Works
Plans with a safe harbor feature promise a special contribution for plan participants; typically, it is either:

  • A match for those who defer into the plan: for instance, dollar-for-dollar up to 4 percent of compensation, or
  • A contribution to all: at least 3 percent of pay to all eligible participants, whether or not they make deferrals into the plan.

A Few Other Benefits
The safe harbor feature brings a variety of other important benefits:
Predictability: Testing failures require a cumbersome refund process or mandate additional contributions by the employer. Safe harbor plans automatically pass these tests, alleviating these concerns: the test will always pass.
Higher Contribution for Key Players: Safe harbor plans allow the highly compensated employees, typically the key players in a business, to defer the full 401(k) amount regardless of the rank-and-file employee participation levels.
Benefit Cost Management: By adding a safe harbor 401(k) feature to an existing profit-sharing plan, the employer may be able to reduce the total cost of mandatory contributions to the rank-and-file while maximizing contributions to key players. Since no complex deferral/match testing and corrections are required for a safe harbor 401(k), this feature significantly reduces plan expenses.
Top-Heavy Requirement: Since a large number of small plans are top-heavy (more than 60 percent of plan assets belong to key participants), a safe harbor becomes a very helpful design feature: it helps satisfy the minimum contribution requirement for most top-heavy plans.
Reduce Profit Sharing Minimum: The 3 percent safe harbor contribution can be counted to satisfy the minimum contribution requirement for cross-tested profit-sharing plans, reducing the mandatory funding component for non-owner employees while maximizing contributions for key players.
Rules of Engagement
To benefit from the safe harbor provision, a plan must follow a few rules:
Let Them Know: The IRS requires employers to provide a safe harbor notice to each eligible participant no less than 30 days and no more than 90 days prior to the beginning of the plan year.
Fund for All Eligible Employees: Safe harbor 401(k) plans cannot require that an eligible participant be employed on the last day of the plan year or work a certain number of hours to receive a safe harbor contribution.
Use Correct Vesting: Safe harbor contributions are usually 100 percent vested. Plans that utilize auto-enrollment can include a safe harbor match, which may be vested over a two-year period.
An Important Deadline
Wednesday October 1, 2014 is the last day to establish a new safe harbor 401(k) or add the safe harbor 401(k) feature to an existing profit-sharing plan.
Who Should Consider a Safe Harbor 401(k) Plan?
Reach out to business owners with at least one rank-and-file employee:

  • Who are interested in a new 401(k) plan;
  • Who are setting up a defined benefit/cash balance and a 401(k) combination plan;
  • Who have an existing Profit Sharing Plan and want to better manager contribution costs; or
  • Who have an existing a defined benefit/cash balance plan and are interested in adding a supplemental 401(k) plan to increase their tax-deductible savings or make their plan work better.

Increase Plan Contribution through Efficient Design
Calendar-year clients have until December 31 to establish their defined benefit and cash balance plans for 2014. The latest regulations greatly expanded the ability of clients to maximize plan savings with a combination plan approach. The October 1 deadline will apply to those clients who want to add a safe harbor 401(k) plan to an existing defined benefit plan, or establish a combination 401(k)/defined benefit plan for the plan year ending December 31, 2014.
As always, our retirement plan solution consultants are ready to help. Call us at 888-926-0600 or send a message to