What Exactly is a Safe Harbor 401k Plan?

One of the lesser known facts regarding 401k retirement plans is that they are subject to three annual tests administered by the IRS. These tests are given in an attempt to lessen the chances of discrimination against lower-wage earners within a company.

However, because these tests can be arduous and, if failed can result in heaps of paperwork and fees; an option to smoothly “sail” past these tests exists in the form of a Safe Harbor 401k plan.

What Do the Annual IRS Tests Consist of?

The three tests of fairness that are administered each year by the IRS are as follows:

The Top-Heavy Test: If you, as the employer, and your most highly compensated employees hold greater than 59% of the total 401k plan balance, your plan is considered “top-heavy” and you will not pass this test for the year.
The ADP or Actual Deferral Percentage Test: Based on the average contributions of lower-wage employees, highly compensated earners are limited in what they can contribute to their 401k plan.
The ACP or Actual Contribution Percentage Test: This test is designed to ensure that matching contributions by the employer are not significantly higher for highly compensated earners as opposed to the lower-wage employees within the company.

Failing any one of these three tests results in piles of paperwork and fees which will cause headaches for you and your business long after the fact.

How Does a Safe Harbor 401k Plan Help Me Pass These Compliance Tests?

Implementing a Safe Harbor provision into your 401k plan allows you to immediately bypass these IRS compliance tests, as the safe harbor plan is structured specifically so that your plan cannot fail any of the three tests.

There are essentially three options for matching employee contributions with a Safe Harbor 401k:

Basic Matching: Employer matches each employee’s 401k contribution completely up to 3% of their yearly compensation. Additionally, the employer must match 50% of the next 2% of employee deferrals.
Enhanced Matching: Employer matches 100% or more of each worker’s 401k contributions, up to 4% of his or her compensation.
Non-Elective Contribution: Employer contributes 3% or more of each employee’s compensation to every participant without regard to employees’ contributions.

How Can I Set Up a Safe Harbor 401k for My Business?

The process for setting up a Safe Harbor 401k plan is as simple as calling a plan representative and requesting a consultation. They will walk you through the necessary steps and ensure that you understand what is required. However, there are some deadlines that you should be aware of in order to not miss your chance for this year:

October 1^st 2021 is the last day to start a new Safe Harbor 401k Plan.
Adding a Safe Harbor provision to an existing 401k plan must be done no later than November 29^th

Bottom Line

In the end, whether or not you should implement a Safe Harbor 401k plan for your business is going to depend on a variety of factors unique to your business. If you have questions or concerns, plan providers are ready and willing to help you at any time.