In this edition of Ekon Explains, we consider the benefits of Safe Harbor provisions in a 401(k) plan, outline the standard contribution and notice requirements, and discuss additional safe harbor options.

Introduction to Safe Harbor 401(k) Plans

Each year, traditional 401(k) plans must successfully pass nondiscrimination testing to ensure that the Plan does not benefit owners and highly compensated employees (HCEs) disproportionately to non-highly compensated employees (NHCEs). Consistent failure of nondiscrimination testing is a primary reason for implementing Safe Harbor provisions, as the adoption of Safe Harbor provisions allows employers to avoid certain testing in exchange for making required contributions to participants.

Key Benefits of Safe Harbor 401(k) Plans

A plan that provides Safe Harbor contributions avoids both Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) testing and, in many cases, Top Heavy testing. The ADP and ACP tests can restrict 401(k) contributions for HCEs, and “top-heavy” plans will result in a required employer contribution to non-key employees. The Safe Harbor plan design enables highly compensated employees to defer greater amounts by avoiding these restrictive tests.

Although an employer contribution is required with Safe Harbor Plans, the tax advantages for the owners and Highly Compensated Employees may far outweigh the costs, especially for small and mid-sized companies.

Customary Safe Harbor Contribution Requirements

In accordance with Safe Harbor rules, the employer must make required contributions to participants to be exempt from non-discrimination testing. This typically takes one of two forms:

1. Non-Elective Contribution: A contribution equal to 3% of compensation for each eligible employee.
2. Matching Contribution: A matching contribution effectively equal to dollar-for-dollar up to 4% of compensation.

The 3% non-elective contribution must be made to all participants regardless of the amount they elect to contribute under the plan, if any.  However, the matching contribution only matches the elective contributions of those participants who make them.  The basic matching formula is tiered and provides a different match as the employee’s elective contribution increases.  The tiered formula produces a maximum match of 4% of compensation but can be confusing to compute.  For this reason, many employers choose to use the enhanced matching formula which is more simply stated as a dollar-for-dollar match up to 4% of compensation.

Key Features of Safe Harbor Contributions

• Vesting: Safe Harbor contributions are fully vested when contributed, meaning the employee has a vested right to their Safe Harbor contribution account as soon as they are eligible to participate.
• No Employment Requirement: The plan cannot require employment at the end of the year or the employee to work a specific number of hours of service to receive the Safe Harbor contribution.

Safe Harbor Notice Requirement

Prior to SECURE 2.0, employers were required to provide an annual Safe Harbor notice to participants at least 30 days (but no more than 90 days) before the beginning of the plan year. As of 2020, plans that use the 3% non-elective Safe Harbor contribution are no longer required to provide this notice, though a notice is still required for matching contribution safe harbors. Safe Harbor provisions generally must be adopted before the start of the plan year, but SECURE 2.0 now allows employers to retroactively elect Safe Harbor non-elective status under certain conditions.

Additional Safe Harbor Options

A Qualified Automatic Contribution Arrangement (QACA) allows plan sponsors to fulfill safe harbor requirements by including an automatic enrollment feature in the plan.

QACA Features:

• The matching contribution maximum is 3.5% versus 4% under the regular Safe Harbor plan.
• A 2-year vesting schedule instead of immediate vesting.