Your Guide to Safe Harbor 401(k)

What is a Safe Harbor 401(k)?

A Safe Harbor 401(k) is a type of retirement savings plan that allows employers to avoid most annual compliance testing that traditional 401(k) plans must undergo. If a company meets the requirements for Safe Harbor matching contributions, it is deemed to be in compliance with certain nondiscrimination tests.

By not having to undergo the annual 401(k) nondiscrimination tests, small businesses can save dozens of hours of work, as well as money, and energy, while still being able to provide their employees with an important benefit.

There are two main types of Safe Harbor 401(k) plans:

Matching contribution plan

Employees can choose to contribute to the plan (known as an elective deferral), and the employer makes a matching contribution up to a certain percentage of the employee's salary. For example, the employer might match 100% of an employee's deferrals up to 3% of their salary.

Nonelective contribution plan

An employer makes a fixed contribution to each employee's account, regardless of whether the employee chooses to make their own elective deferrals. For example, the employer might contribute 3% of an employee's salary to the employee's 401(k) account.

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Read more about 401(k) retirement plans.

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What is the benefit of Safe Harbor 401(k)?

Safe Harbor 401(k) plans offer many benefits for both business owners and employees, including employer contributions, automatic enrollment, a 2-year vesting schedule, and simplified compliance. If your employer offers a Safe Harbor 401(k) plan, you should consider participating.

Main benefits of Safe Harbor 401(k) retirement plans for employers:

• Simplified compliance: Safe Harbor 401(k) plans are exempt from the complex annual nondiscrimination tests that apply to traditional 401(k) plans. This means that employers do not have to worry about whether the plan is meeting these tests, which can save them time and money on compliance costs. 
• Increased employee participation: If an employer chooses a nonelective contribution Safe Harbor 401(k) plan, it's more likely that their employees will continue participating. A 2023 Vanguard study found that plans with automatic enrollment had a 93% participation rate, compared with 70% employee participation for plans with voluntary enrollment. 
• Reduced top-heavy risk: Safe Harbor 401(k) plans are exempt from the top-heavy rules. According to the IRS, "plan is top-heavy when, as of the last day of the prior plan year, the total value of the plan accounts of key employees is more than 60% of the total value of the plan assets." In layman's terms, that means the highest-paid employees are getting more benefits from the 401(k) plan than the lowest-paid employees. But with a Safe Harbor 401(k), employers do not have to worry about these rules. 
• Improved employee morale: A study in 401(k) Specialists found that employees who are offered a Safe Harbor 401(k) plan may be more likely to stay with their current employer. While providing a retirement plan for employees can be expensive, it's ultimately a smart retention tool that can save money in the long run.
• You can attract and retain top talent: A Safe Harbor 401(k) plan can be a valuable benefit for employees, and it can help to attract and retain high-value employees.

Main benefits of Safe Harbor retirement plans for employees:

• Employer contributions: This is a bit like getting a raise. With a Safe Harbor 401(k), an employer makes a contribution to each employee's account, and in the case of nonelective contribution plans, they will make those contributions regardless of whether the employee makes elective deferrals. This can help employees save for retirement, even if they cannot afford to contribute to the plan on their own.
• Automatic enrollment: Automatic enrollment is a feature of many Safe Harbor 401(k) plans, which automatically enroll eligible employees in the plan unless they opt out. The default contribution rate for automatic enrollment is typically 3% of salary

How does a Safe Harbor plan work?

A Safe Harbor 401(k) plan operates much like a traditional 401(k) plan, with the key difference being the way employer contributions are handled.

Here's a step-by-step breakdown:

1. Establishing the plan: An employer establishes the Safe Harbor 401(k) plan and chooses the type of employer contribution they will provide. They can either opt to give nonelective contributions or matching contributions.
2. Employee participation: Employees are given the opportunity to participate in the plan. They can decide how much of their pre-tax and post-tax salary they want to contribute, up to the annual limit set by the IRS.
3. Employer contributions: The employer contributions are based on the type of Safe Harbor plan they've chosen, up to the annual limits set by the IRS.
4. The nonelective contribution: Safe Harbor plan requires the employer to make a contribution equal to at least 3% of the employee's compensation to all eligible employees, regardless of whether the employee makes any contributions.
5. The matching contribution: Safe Harbor plan allows employers to choose a matching contribution ranging from 3.5% to 6% if you have auto enroll (like Penelope) or 4% to 6% if you don’t have auto enroll.
6. Notice to employees: The employer is required to provide all eligible employees with a notice before the beginning of each plan year. This notice will detail their rights and obligations under the plan.
7. Avoiding nondiscrimination tests: Because the employer makes these contributions, the Safe Harbor 401(k) plan is not subject to the usual nondiscrimination tests (ADP and ACP tests) that traditional 401(k) plans must pass.
8. Investing the funds: The employee's and employer's contributions are invested according to the employee's selections from the investment options offered within the plan.
9. Distributions: Generally, the funds in the account grow tax-deferred until the employee withdraws them, usually in retirement (at 65 or older).

Requirements for a Safe Harbor 401(k)

Here are the main requirements and overview of this type of retirement plan you can offer your employees:

Safe Harbor contribution limits

The Safe Harbor contribution limits for 401(k) plans are the same as the contribution limits for traditional 401(k) plans. In 2024, the maximum employee contribution is $23,000. 

For those who are 50 years of age or older, there is a catch-up contribution of $7,500, bringing the total contribution limit to $30,500.

The employer's contribution to a Safe Harbor 401(k) plan is not subject to the same contribution limits as the employee's contribution. The amount of the employee’s compensation that can be taken into account when determining the % of the employer contribution is limited to the annual compensation limits set by the IRS.

Safe Harbor deadlines

There are a few important deadlines that employers need to keep in mind when sponsoring a Safe Harbor 401(k) plan.

• Notice requirements: The employer must provide notice of the Safe Harbor 401(k) plan to employees at least 30 days before the start of the plan year. 
• Contribution deadline: The employer must make its Safe Harbor retirement contributions by the last day of the plan year.

Important dates for new plans

• Plan Establishment Date: In general, new Safe Harbor 401(k) plans must be established and the Safe Harbor notice must be provided to eligible employees at least three months before the end of the plan year. This typically means that the plan should be set up no later than October 1st for a calendar-year plan.
• Notice Distribution Date: Employees must receive the Safe Harbor notice at least 30 days but no more than 90 days before the beginning of each plan year. For a calendar-year plan, this typically means notices must be distributed between October 2nd and December 1st.
• Plan Start Date: The plan generally starts on January 1st for calendar-year plans, which is when the Safe Harbor provisions become effective.
• Contribution Start Date: The employer's Safe Harbor contributions (either matching or non-elective) must begin when the plan starts and must be made for the entire plan year.

What are the employer contribution options for Safe Harbor 401(k) plans?

For Safe Harbor 401(k) plans, employers have two main types of contribution options: nonelective contributions and matching contributions. 

1. Nonelective Contributions: In this option, the employer contributes 3% of compensation to all eligible employees, regardless of whether the employees contribute to their 401(k). This means that even if an employee decides not to put any of their own money into the 401(k) plan, they would still receive a contribution equivalent to 3% of their salary from the employer. To satisfy the Safe Harbor requirements, these contributions from the employer must be 100% vested when made, meaning that they are immediately owned by the employee.
2. Matching Contributions: Under this option, the employer chooses a matching contribution of 3.5% to 6% if you have auto enroll (like Penelope) or 4% to 6% if you don’t have auto enroll. This means that the employer matches 100% of the first 1% of compensation for the employee who decides to contribute, and then 50% of the next 5% of compensation.
3. So if an employee contributes 6% of their salary to the plan, the employer would contribute 3.5% (100% match on the first 1%, and a 50% match on the next 5%). The contributions from the employer, in a Qualified Automatic Contribution Arrangements (QACAs) Safe Harbor 401(k) plan, would require the employee to work for the company for 2 years before they are owned by the employee.

Remember, the specific rules and regulations around Safe Harbor 401(k) plans can be complex so please consult with our qualified retirement plan professionals here at Penelope.

401(k) nondiscrimination testing

401(k) nondiscrimination testing is a set of rules that are designed to ensure that 401(k) plans do not discriminate in favor of highly compensated employees (HCEs). The tests are designed to ensure that all employees, regardless of their income or job title, have an equal opportunity to participate in the plan and to benefit from the plan's contributions and earnings.

There are two main types of 401(k) nondiscrimination testing:

Actual Deferral Percentage (ADP) test

The ADP test compares the average deferral rates of HCEs to the average deferral rates of non-highly compensated employees (NHCEs). The plan must pass the ADP test in order to avoid the application of certain penalties.

Actual Contribution Percentage (ACP) test

The ACP test compares the average contributions of HCEs to the average contributions of NHCEs. The plan must pass the ACP test in order to avoid the application of certain penalties.

Traditional vs. Safe Harbor 401(k) Plans

The main difference between traditional and Safe Harbor 401(k) plans is that Safe Harbor plans are exempt from the annual nondiscrimination testing requirements. This means that employers who sponsor Safe Harbor 401(k) plans do not have to worry about whether the plan passes the ADP and ACP tests.

Another difference between traditional and Safe Harbor 401(k) plans is that Safe Harbor plans require employers to make either a matching contribution or a nonelective contribution. This is not the case with traditional 401(k) plans, where employers are not required to make any contributions.

Would you like to offer your employees Safe Harbor 401(k) retirement plans?  Get started today with a free, no-obligation consultation with a 401(k) retirement specialist.