Spoiler alert: not always. *Safe Harbor 401(k) plans generally automatically satisfy Top Heavy requirements, except for plan years in which the employer makes discretionary contributions (such as profit sharing contributions) in addition to Safe Harbor contributions. Employers who want to open a safe harbor 401(k) plan should seek professional guidance. While a traditional 401(k) plan can have a vesting schedule of up to a three-year cliff or six-year graded for employer contributions, those same contributions to a safe harbor plan are completely and immediately vested. Why? (At Guideline, November 20, 2022 is your last day to add Safe Harbor matching provisions to your 401(k) to take effect in 2023. December 2019 The Internal Revenue Service recently issued final regulations governing "safe harbor" hardship withdrawals from Section 401 (k) plans. Cookies collect information about your preferences and your devices and are used to make the site work as you expect it to, to understand how you interact with the site, and to show advertisements that are targeted to your interests. But is that really the best advice? A unique disadvantage to a safe harbor plan design is the vesting schedule. (Note: The new nonelective rule was passed by Congress in late 2019 under the SECURE Act and gives more flexibility for those plans who didnt know they were going to fail nondiscrimination testing and would like to rectify.). No employers can match any contribution beyond the four percent threshold. According to the IRS, there are three general nondiscrimination rules traditional 401(k) plans must follow: To show the IRS that a companys 401(k) plan meets those requirements, the plan has to go through a series of annual nondiscrimination tests that are used to figure out whether or not the plan is fairly balanced. A safe harbor 401 (k) plan defines compensation as Form W-2 wages (that is, the amount shown in an employee's W-2, Box 1, Wages, tips, other compensation), less reimbursements, fringe benefits, moving expenses, and welfare benefits. Features of a Safe Harbor Plan Establishing a safe harbor plan where the only contributions are safe harbor contributions, elective deferrals and The SECURE Act also provides that companies can amend their plans to safe-harbor plans up until the 30th day before the plan year ends. If so, then a Safe Harbor 401(k) that's generally available to all employees might be a better way to go depending on your specific circumstances. Top heavy implications . Designing a plan to meet safe harbor requirements does not guarantee that the plan is administered in accordance with the plan provisions. "The Setting Every Community Up for Retirement Enhancement Act of 2019 (The SECURE Act)," Page 1. Your "vested percentage" in your account attributable to qualified safe harbor contributions is determined under the following schedule. Learn More. Factors to consider prior to eliminating safe harbor contributions from a 401(k) Plan . Lets run through the benefits and drawbacks of a safe harbor 401(k) really quickly. "Tax Consequences of Plan Disqualification." So if an employee defers at least 5% of pay, then the Basic Match is equal to 4% of pay. Limitations exist on the amount of wages an employee can contribute to a 401k plan. A Safe harbor 401(k) plan allows a plan sponsor to automatically pass certain annual tests to ensure compliance with IRS regulations if specific contribution, vesting, and participant notification requirements are met. Making mid-year changes to a Safe Harbor plan It's a way to structure a plan that automatically passes the test or avoids it altogether. That's 6% of your $150,000 salary. A safe harbor 401(k) plan is exempt from many of the compliance requirements applicable to traditional 401(k) plans, such as ADP testing, provided it meets certain rules. Basic matching: The company matches 100% of all employee 401(k) contributions, up to 3% of their compensation, plus a 50% match of the next 2% of their compensation and have not been previously reviewed, approved or endorsed by any other For example, a more generous employer can match up to 6% of employees pay, and it could still qualify as Safe Harbor. Accessed Dec. 2, 2021. Vesting Schedule This article provides generalguidelines about investingtopics. The following are the available 401(k) safe harbor match and contribution options: -- Basic safe harbor: Also known as an elective safe harbor, this plan will match 100% of contributions up to 3% of an employee's compensation and then 50% of an employee's additional contributions, up to 5% of pay. On the employer side, having a safe harbor 401(k) could mean increased payroll costs, but it could also mean lower administrative costs. September 1, 2022: 30-day notice must be sent to employees. Here are examples of the different contribution formulas: 1. A Safe Harbor 401(k) can generally help you avoid the uncertainty surrounding annual testing.*. When employers take this step to encourage more employees to participate, the IRS offers them safe harbor from certain nondiscrimination testing processes and the consequences of failure. Those contributions are vested immediately. These tests compare both plan participation and contributions of rank-and-file employees to owners and managers to make sure the plans are fairly benefitting both groups. A safe harbor 401 (k) plan is a plan that includes a cash or deferred arrangement described in IRC 401 (k) (12) (traditional 401 (k) safe harbor) or IRC 401 (k) (13) (qualified automatic contribution arrangement ("QACA") safe harbor). Enhanced Safe Harbor Match: The employer matches 100% of the first 4% of each employee's contribution. Highly compensated employees are those who earn more than $130,000 in annual income, those who are employed in the company, and who own at least 5% of the company, or those who are part of a family that owns at least 5% of the company. Implementing a safe harbor 401(k) could increase your payroll costs by 3% or more depending on what safe harbor option you choose and how much your employees decide to contribute into their plans. If your plan were to fail one of these tests, it could mean making expensive corrections, a lot of administrative work, and potentially even refunding 401(k) contributions. All rights reserved. By setting up a safe harbor 401(k), a business can provide its employees with the same tax benefits as a regular 401(k) plan but skip the onerous annual testing requirements. Learn About 401(k) Vesting and What It Means for You. There are a couple of downsides to a safe harbor plan we have to talk about. But many companies think the upside more than outweighs the cost. Weve mentioned these nondiscrimination tests a couple times already, but what exactly is the deal here? 3. Notice must be given within a reasonable amount of time at least 30, but not more than 90 days before the beginning of the plan year. Learn how to set up a Safe Harbor 401(k) and what problems it can solve for businesses. If you choose a safe harbor plan with basic or enhanced matching, non-HCEs will be encouraged to put money into their 401(k)s so that they can get the employer match. Another popular plan design option is the traditional 401(k). This is what the matching and nonelective contributions would look like for an employee under the three different Safe Harbor formulas. IRS. Employer Contribution (a) An Employer contribution for health and dental benefits will only be made for each active employee who has at least eighty (80) paid . You probably already know that offering a 401(k) makes it easier for employees at your company to save more for retirement. See Reg. Your situation may beunique. Verifying the correct definition(s) of compensation are used for contributions and deferrals. You want a way to maximizecontribution limits for yourself and other key employees. Current market conditions bring both opportunity and risk. Option 2 - Safe Harbor 4% Matching Basic- Match 100% of the first 3% of compensation, plus 50% of the next 2% of compensation, or. The plan document must be amended to reduce or suspend the safe harbor contribution and to add the required nondiscrimination testing provisions for the plan year: the "actual deferral percentage" ("ADP") test for 401(k) plans and the "actual contribution percentage" ("ACP") test for plans with matching contributions, both of . Finally, any other definition of compensation generally satisfies IRC Section 414(s) if the definition meets three criteria: For purposes of the reasonable element in determining if a definition of compensation meets the requirements of IRC Section 414(s), a plan may not exclude compensation in excess of a specific amount for non-highly compensated employees. the safe harbor match) that vest immediately. What happens if your plan fails one or more of those tests? This reduces the administrative burden faced by employers and ensures that the retirement plan meets IRS rules for non-discrimination. This is how the HCE provisions can limit 401 (k) plan contributions by highly compensated employees. Traditional 401k plans can have a long vesting period for employer contributions. The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law in December 2019. One of your many responsibilities as a small-business owner is to find the best way to help your employees save for retirement. A company can provide an incentive for employees to stick around longer by putting them on a vesting schedule with a traditional 401(k) plan. If the employer fails (the tests), its very punitive, says Steven Azoury, owner of Azoury Financial in Troy, Michigan. Employers of any size can use Safe Harbor 401(k . Having a match is really enticing for employees, Gottfried says. Maybe youve already set up a 401(k) plan at your workplace, but all the tests and hoops you have to jump through to meet the IRSs rules and standards are driving you nuts. And if youre still on the fence about whether or not a safe harbor 401(k) is right for your business, you dont have to make that decision alone! You'll need to match 100% of the first 3% of an employee's contribution, then 50% on the next 2%. Because if their highly compensated employees and key employees invest too heavily into the companys retirement plan, theres a chance the plan might not pass those nondiscrimination tests, which could lead to some costly consequences! How Do Tax Reforms for 401(k) Plans Affect You? Requirements for a Safe Harbor 401 (k) To fulfill the safe harbor 401 (k) requirements, the employer must make qualifying 401 (k) contributions (a.k.a. The nondiscrimination tests analyze the savings rates of highly compensated employees compared to non-highly compensated employees. It checks to make sure the highest-paid employees or business owners don't max out their 401(k) plan contributions for the year while other employees contribute much less. Employers must match employee contributions on a consistent basis. Under the SECURE Act, if you want to add a Safe Harbor Nonelective provision to your plan, but it is after December 1, 2022, it must be at least 4%. It's easy to do, but it will require the employer to make contributions for certain employees. . This 401(k) retirement plan offers generous perks for small business owners and employees alike. Small-business owners and employees love the safe harbor option because it makes it easier to meet the rules set by the government and workers get some kind of contribution to their retirement plans. Several types of changes are not permissible during the year, however, so review the rules carefully if you wish to amend your plan. With a safe harbor 401(k) plan, everyone can contribute up to the $19,500 maximum in 2021 (and $20,500 in 2022), and those age 50 and older can make an additional $6,500 in catch-up contributions. See Reg. The IRS is increasing the maximum individual 401(k) contribution limit by $1,000 - from $19,500 to $20,500 in 2022.The Safe Harbor 401(k) contribution limit for 2022 is the same as a Traditional 401(k), even though Safe Harbor plans are exempt from most nondiscrimination testing. Accessed Dec. 2, 2021. Safe Harbor deadlines The plan can provide that the 3% non-elective employer contribution will be based on Susans compensation for the period of September 1, 2016 to December 31, 2016. A third test, the Top-Heavy test, looks at individuals the IRS defines as key employees and measures the value of the assets in their 401(k) accounts, compared to all assets held in the 401(k) plan. The company kicks in a minimum of 3-4% of their salaries, either contingent on a matching contribution or not (see: nonelective). As an added benefit, with Safe Harbor provisions in place and less to to worry about when it comes to nondiscrimination testing, owners and highly compensated employees can truly max out their deferrals. To make sure everyone has a chance to benefit from the plan their employer offers, the IRS has set up a series of what it calls nondiscrimination tests that are designed to measure whether a 401(k) plan unduly favors highly compensated employees. In general, Safe Harbor plans are a good choice for companies that do any of the following: In terms of pros and cons, the biggest downside to offering a Safe Harbor plan is the cost of the contributions your company will make. Each eligible employee must be notified in writing about their rights and obligations under the plan annually if the plan includes matching or automatic enrollment features. December 31, 2023: Deadline for adopting a 4% Safe Harbor Nonelective provision to your 401(k) plan with Guideline for the 2022 year (request the amendment by December 1, 2023). Safe harbor 401(k) plans are typically less expensive to set up than traditional plans. The IRSwants to see thatall take advantage of the plan, not just those with high-paying jobs. The maximum discretionary match may not exceed 4.00 percent of pay. Larger businesses might have the team and resources in place to keep up with all those requirements, but it can get very time-consuming and expensive for smaller businesses to keep up with. House Committee on Ways and Means. The safe harbor 401 (k) was created as part of the Small Business Job Protection Act of 1996. However, the Safe Harbor 401k is not subject to many of the complex discrimination and compliance rules that are associated with a Traditional 401k plan, including the ADP and Top-Heavy tests. And remember, whether you make matching or nonelective safe harbor contributions, that money is immediately vested when it hits your employees accounts. If key employees own more than 60% of the assets in a plan, it is considered top-heavy and corrective action may be required. (Getty Images). Failed tests usually either require an employer contribution to the non-highly compensated employees or a refund of contributions from the highly compensated employees, says Don Recker, partner and director of corporate retirement plans at Creative Planning, a comprehensive wealth management firm based in Overland Park, Kansas. Section 1.414(s)-1(d)(2), and (iii) satisfies the nondiscrimination requirement set forth in Reg. it satisfies the nondiscrimination requirement set forth in the regulations. For workers, a standard 401(k) plan offers a straightforward and tax-advantaged way to save for retirement, but for employers, setting up a 401(k) plan is anything but simple. If the plan is making a nonelective contribution of 3% to all employees, it automatically satisfies the top-heavy contribution requirement. In 2020, employees can deduct from their taxable income up to $19,500 in contributions to a traditional 401(k) plan of any type. For example, you could put a new employee on a five-year vesting schedule where the company increases the amount they are vested in by 20% every year. Search online, or ask fellow business owners or financial professionals in your area to suggest retirement planproviders who can help you set up a 401(k) or custom retirement plan for your small business. Section 1.414(s)-1(d). A Safe Harbor plan is a special kind of 401(k) that automatically satisfies most nondiscrimination testing. Read on to learn more about safe harbor 401(k) rules, including how they're set up, how they meet government requirements and ways to benefit from employer-matched contributions. Section 1.414(s)-1(c)(2). You have more options with a safe harbor plan. Sixty-eight percent of small business 401(k) plans use a safe harbor design to avoid annual compliance testing. Option 1 - Safe Harbor 3% Nonelective In a 401 (k) plan, "nonelective" means "not conditioned on employees making 401 (k) contributions", so under this first option the safe harbor nonelective contribution is made as 3% of gross pay to all eligible plan participants whether or not they make 401 (k) contributions. The definition will satisfy IRC Section 414(s) if it (i) does not by design favor highly compensated employees, (ii) is reasonable within the meaning of Reg. In a safe harbor 401 (k) plan, HCEs are therefore able to maximize their salary deferral contributions at the IRS limit (*) without any possibility of an ADP testing failure resulting in "corrective taxable refunds". Comparative assessments and other editorial opinions are those of U.S. News You can find out more about our use, change your default settings, and withdraw your consent at any time with effect for the future by visiting Cookies Settings, which can also be found in the footer of the site. You can even add a profit-sharing component and still pass compliance testing. The IRS can reject a retirement plan contribution that it believes is excessive. This is especially true when it comes to vestingwhich is a term used to talk about how much of someones employer contributions belong to them if they leave their job. Lets quickly run through each of those three options: These numbers are just minimums for a safe harbor match or contributions. It increased the limit for automatic increases in an employee's deferrals from 10% to 15%. Time to drop the disability coverage and review your other plans. This entails using one of the following formulas-. The first two are matching options where your employees have to put money into their retirement account in order to receive contributions from their employer. A safe harbor 401 (k) is structured so that all employees receive employer contributions to their retirement plan. I had always thought that the deadline for us to deposit the match is the due date of our company tax return (with extensions), but my TPA mentioned something about a quarterly deposit requirement. Compensation in a safe harbor 401(k) plan may either be limited to an eligible employees period of participation or be for the entire plan year even though the employee only participated for part of the year. A safe harbor 401(k) is structured so that all employees receive employer contributions to their retirement plan. There's always a catch in the "harbor.". In addition to the ADP test, an employer can use safe harbor contributions to avoid the ACP test as well, provided these four criteria are met: Matching contributions under the plan may not be based on deferrals that exceed 6.00 percent of pay. The enhanced safe harbor 401 (k) lets employers match 100 percent of employee contributions up to four percent of their paid wages. Melissa Phipps is a retirement planning and investing expert who has covered those topics for more than 20 years as a writer, editor, and author. "401(k) Plan Overview." It is important to be aware that if a Safe Harbor feature is added to a new plan, it must be in place for the entire plan year. He has eights years' experience in finance, from financial planning and wealth management to corporate finance and FP&A. And then there's a third option where your company would . But the government wants to make sure that everyone not just highly compensated employees gets to participate in a meaningful way. The 4% match might even cost less than the top heavy minimum contribution if participants defer at low rates. Section 1.401(k)-3(b)(2) (last sentence). Enter Our Giveaway for a Chance to Win Cash! An official website of the United States Government. It's possible they could increase your overall payroll by 3% or more if all employees participate. With a standard 401(k), an employee may have to work a certain number of years before they have full access to this money, but no such lengthy predetermined vesting schedule is in place with most safe harbor plans. As cash flow and decreased revenue concerns rise, many safe harbor 401(k) plan sponsors looked to suspend employer contributions, weighing the consequences of such suspensions. Market chaos, inflation, your futurework with a pro to navigate this stuff. Try these strategies to boost your retirement savings without significant sacrifices. The company contributes to employees' retirement accounts in one of three ways: Non-elective: The company contributes the equivalent of 3% of . They would have to stay five years before becoming fully vestedonly then would they get to keep all of their employers contributions. IRS. If My Company Closes, What Happens to My 401(k)? If the employer doesn't fix things, the plan could lose its tax-qualified status. Sometimes it makes more sense for one member of a married couple to keep working. For example, a definition of compensation that includes all compensation within the meaning of IRC Section 415(c)(3) and excludes all other compensation automatically satisfies IRC Section 414(s). Senior insurance needs are different. Even if companies dont think they need a safe harbor 401(k) now, Beck says its something for business owners to consider as some states weigh legislation to regulate retirement plans. And then theres a third option where your company would have to make contributions across the board regardless of whether your employees contribute or not. And lets be real, nobody wants to go through testing if they dont have to! it does not by design favor highly compensated employees, it is reasonable within the meaning of Reg. Accessed Dec. 2, 2021. Section 1.401(k)-3(b)(2), and Reg. The safe harbor nonelective contribution requirement of this paragraph is satisfied if, under the terms of the plan, the employer is required to make a qualified nonelective contribution on behalf of each eligible NHCE equal to at least 3% of the employee 's safe harbor compensation . Workers could not roll over plan assets to other eligible retirement plans. Basic Safe Harbor Match: All eligible employees who contribute to the company's traditional 401 (k) plan can benefit from this Safe Harbor option. August 19, 2022: Deadline for setting up your Guideline Safe Harbor 401(k) Plan for the current year. A safe harbor 401k is a specific plan structure that automatically passes the non-discrimination test or avoids it altogether. Other 401(k) plans might be better choices if you think your business could have trouble consistently matching funds. The government-required tests also aim to assess whether the account contributions are top-heavy. Notice should be given 30 to 90 days before the changes go into effect. 2022 Limitations Adjusted as Provided in Section 415(d), Etc. All the details for mid-year changes are included in IRS Notice 2016-16, but these are the basic things the IRS requires: Once youve satisfied the notice rules above, you may be able to make changes to certain aspects of the plan including, for example, increasing future safe harbor non-elective contributions from 3% to 4%, or changing the plan entry date for eligible employees from quarterly to monthly. Before you learn the basics of safe harbor plans and how they're structured, you must understand the government nondiscrimination testing for regular 401(k) accounts. Safe Harbor plans require that you contribute to your employees retirement 401(k) accounts in one of two forms: a match or a nonelective contribution. In a Safe Harbor plan, the employer elects to make one of two types of immediately-vested contributions: 1. The third option requires your company to make a contribution, even if employees dont defer any of their income into their plan. If that employee leaves after three years, they can only take 60% of their employers contributions with them. That means they can take full advantage of their contribution limits. That would put higher-paid workers in line with those who aren't fully active. DOL provides a 7-business-day safe harbor rule for employee contributions to plans with fewer than 100 participants. Our SmartVestor program can connect you with a financial advisor who isready to answer your questions and walk you through all of your options. Taking classes keeps your mind sharp, helps you network and may even be free. Basic Match formula - 100% match on the first 3% of pay deferred, and 50% on the next 2% deferred. You are advised to consult a qualified financial adviser or tax professional before relying on the information provided herein. A safe harbor 401(k) planwith its mandatory employer contributions and immediate vesting for employeescan help your business sidestep that testing altogether because it is set up in a way that naturally meets the IRS requirements. To do that, the tests compare the fund assets of key employees to those of everyone else. The other is to recast the excess contributions of highly paid workers as taxable income. Or in a worst-case scenario, the whole plan could be disallowed going forward, according to Azoury. A non-elective contribution to all eligible participants: a minimum of 3% of pay a "maybe" election is an option (see Question 5 below for more information) WHAT CONTRIBUTIONS MUST THE COMPANY MAKE TO A SAFE HARBOR 401 (k) PLAN? A safe harbor 401(k) plan is one that's set up to give employers some flexibility regarding IRS non-discrimination rules for contributions. Another option is to get assistance from an advisory firm that can determine how a retirement plan fits into the big picture of company finances and goals. on this page is accurate as of the posting date; however, some of our partner offers may have expired. All safe harbor plans must immediately vest employer contributions for an employee unless they use the QACA contribution which allows for up to a 2-year vesting schedule. That means you dont have to lose sleep at night wondering if your 401(k) will pass the IRSs tests! Heres why. 10 Strategies to Maximize Your 401(k) Balance. What to Do If You Lose Money in Your 401(k). You can maximize your contributions to your own account but are required to provide a match to employees as a percentage of compensation. In exchange for avoiding nondiscrimination (e.g., actual deferral percentage (ADP)) and top-heavy testing, plan sponsors of safe harbor 401 (k) plans have to make mandatory employer contributions and provide an annual written notice to employees. Related to 401(k) Safe Harbor Matching Employer Contributions Formula. entities, such as banks, credit card issuers or travel companies. Don't worry. If you havequestions, connect with aSmartVestorPro. That way, you can make the best decision for your business. Good question! Regardless of the type of 401(k) plan a client sets up, there are impactful tax savings to be had. A safe harbor 401(k) may be a good fit depending on your business requirements, employee pool, capacity to match contributions, and ability to undergo compliance testing. Plan participants must get a lot of written notice and education. If the employer doesn't make the deposits timely, the failure may constitute both an operational mistake, giving rise to plan disqualification (if the plan specifies a date by which the employer must deposit elective deferrals . Safe harbor 401(k) plans tend to be better for companies with steady revenue streams. Most people tell you to take the 401(k) company match no matter what. Trying to decide what kind of 401(k) plan is right for your business is a massive decision. See Reg. For 2021, a highly compensated employee is categorized as a worker earning more than $130,000 annually in the preceding year or someone who owned more than a 5% interest in the business during the previous year. A company's contributions to its employees' 401(k) plans have a big impact . Heres how much you can put into your account in 2021. In exchange, companies must contribute to their employees' 401(k) accounts using a specific formula. 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