During the last decade, 401(k) plans have become the country’s most popular retirement plan. Employers recognize that a 401 (k) plan will help attract and retain employees. However, many small employers have not established a 401(k) plan because of administrative costs and difficulty in passing nondiscrimination tests that apply to employee deferrals and employer matching contributions. To encourage more employers, especially smaller firms, to establish 401(k) plans, Congress established the safe harbor 40J(k) plan. A safe harbor 401(k) plan can be established beginning in 1999.
What is a safe harbor 401(k) plan?
A safe harbor 401(k) plan is not a separate type of plan. Rather, it is a traditional 401 (k) plan that includes certain “safe harbor” provisions. As with any 401(k) plan, employees may contribute a portion of their salaries to the plan on a pre-tax basis. But with a safe harbor 401 (k) plan, there are certain contributions which an employer is required to make on behalf of the employees. Because of these required contributions, the safe harbor 401(k) plan is not subject to many of the complex rules that apply to the traditional type of 401(k) plan.
Why would an employer or an employee want a safe harbor 401(k) plan?
From the employers or an employee want a viewpoint, the safe harbor 401(k) plan, like a traditional 401(k) plan, can help attract and retain qualified employees; provide an immediate tax deduction to the employer; provide a low-cost, visible benefit for employees; and save the employer money by allowing employees to share in the cost of their retirement program.
However, a safe harbor 401(k) plan is not subject to many of the complex nondiscrimination tests that apply to a traditional 401(k) plan. These tests limit the amount of employee pre-tax contributions and employer matching contributions that may be made on behalf of highly compensated employees. The limit is based on the level of contributions made or received by the nonhighly compensated employees. Thus, in a traditional 401(k) plan, low levels of participation by nonhighly compensated employees generally reduce the benefits that can be provided to highly compensated employees. A safe harbor 401(k) plan is not subject to these limits. In a safe harbor 401 (k) plan, the amount of employee pre-tax and employer matching contributions is not affected by the level of participation of the nonhighly compensated employees.
From the employee’s perspective, the safe harbor 401 (k) plan provides an easy method to save for retirement, provides for an immediate tax savings, allows a greater investment return (on a tax-deferred basis) than most individual savings programs, and offers the opportunity to accumulate significant amounts of capital in a relatively painless way.
What types of employers may establish a safe harbor 401 (k) plan?
A safe harbor 401 (k) plan can be sponsored by the same employers which can maintain a traditional 401(k) plan. Except for governmental employers, all types of employers, including tax-exempt entities, may establish a safe harbor 401 (k) plan.
How much may an employee contribute to a safe harbor 401 (k) plan?
An employee may elect to contribute, on a pre-tax basis, the same amount that could be deferred under a traditional 401(k) plan – $23,500 for 2025. This limit will be increased each year for inflation in $500 increments. Those 50 & older can defer a catch up contribution of $7,500.
In addition, because the safe harbor 401(k) plan is not subject to certain nondiscrimination tests, the highly compensated employees will be able to defer the maximum amount permitted based upon their salary level, regardless of what the nonhighly compensated employees defer.
What do the safe harbor 401(k) provisions require?
In order to be safe harbor 401 (k) plan, two requirements must be satisfied. First, employees must be given notice regarding the plan. Second, the employer is required to make certain contributions to the plan.
What employee notice requirements apply?
Each eligible employee must be provided with written notice of the employee’s rights under the plan. The employer must provide this notice between 30 and 90 days before the beginning of each plan year. If an employee becomes eligible after the beginning of the plan year, the employer must provide the notice no more than 90 days before, and not later than the day the employee becomes eligible.
How much must the employer contribute to a safe harbor 401 (k) plan?
Employer contributions are required to be made to a safe harbor 401(k) plan. The contributions are only required to be made to nonhighly compensated employees. However, if desired, contributions can be made on behalf of highly compensated employees as well as nonhighly compensated employees. There are three different safe harbor contribution alternatives.
The first two alternative contributions are matching contributions that are based upon an employee’s pretax deferrals. The more an employee contributes on a pre-tax basis, the larger the employer’s required contribution generally will be.
An employer using the basic matching contribution alternative would contribute that matches 100% of the first 3% of each participating employee’s pre-tax deferral, plus an additional 50% matching contribution for pre-tax deferrals that exceed 3% but do not exceed 5% of the employee’s compensation. For example:
Note: If the employee pre-tax deferral were 6% of pay, the employer match in this example would remain at $1,080. This is because the employer must match only an employee’s pre-tax deferral up to the first 5% of pay.
Alternatively, an employer can use the enhanced safe harbor matching contribution alternative. The employer may design a matching formula which equals or exceeds the safe harbor matching formula at each level of elective deferrals. For example, an employer may provide a matching contribution formula of 100% of elective deferrals not more than 4% of compensation.
The third alternative contribution is not based on an employee’s pre-tax deferrals. Under this alternative, the employer must contribute 3% of the pay for each eligible employee who has worked for the employer during the year, even if that employee has not deferred to the plan.
May the employer contribute more to a safe harbor 401 (k) plan?
Yes- The safe harbor contributions are minimum contributions. Additional employer contributions are permitted. For example, the employer may make matching contributions in addition to the safe harbor contributions. The employer also may make profit sharing contributions.
There are, however, certain limitations an employer must meet to avoid having any additional matching contributions subject to nondiscrimination testing. We will be glad to discuss these limitations with you.
Are there special eligibility rules to a safe harbor 401 (k) plan?
Yes. As with any 401(k) plan, a safe harbor 401(k) plan may require an employee to satisfy eligibility conditions before entering the plan and becoming eligible to receive a safe harbor contribution. For example, a safe harbor 401(k) plan may require an employee to attain age 21 and complete one year of service before the employee may participate in the plan. In addition, a safe harbor 401(k) plan may exclude certain classifications of employees as long as a certain percentage of nonhighly compensated employees are still eligible.
However, once an employee is a participant in the plan, the plan cannot require the participant to satisfy other annual conditions such as employment at the end of the year or the completion of 1000 hours of service, in order to receive the safe harbor contributions. Any participant who is employed during the plan year must be eligible to receive the safe harbor contribution.
May the employer maintain other retirement plans in addition to the safe harbor 401 (k) plan?
Yes. The employer may maintain other plans in addition to the safe harbor 401 (k) plan.
Does all the money in a safe harbor 401 (k) plan belong to the participating employees?
No. Each employee is immediately 100% vested in both pre-tax deferrals and in the employer safe harbor contributions. However, if the employer makes additional matching or profit-sharing contributions, these contributions may be subject to a vesting schedule.
May an employee direct the investments in a safe harbor 401 (k) plan?
Yes. The employer may permit participants in a safe harbor 401(k) plan to direct their investments. This is a plan design feature which we can review with you.
May an employer establish a safe harbor 401 (k) plan mid-year?
Generally, an employer must make safe harbor contributions for a 12-month plan year. The only exception to the 12-month rule is for the first year of a new safe harbor 401(k) plan. A new safe harbor 401(k) plan may have a plan year as short as 3 months.
Can employees withdraw their funds from a safe harbor 401 (k) plan before retirement?
Safe harbor contributions are distributable only on account of a participant’s separation from service, death, disability, or attainment of age 59½. Safe harbor contributions are not eligible for hardship withdrawal.
What are the primary differences between a SIMPLE 401 (k) plan and a safe harbor 401 (k) plan?
First, the limit on employee pre-tax deferrals is $16,500 for a SIMPLE 401 (k) plan versus $23,500 for a safe harbor 401(k) plan. However, the employer contribution requirement is less in the SIMPLE plan: the employer either makes a 2% employer contribution to all participating employees, or a matching contribution of 100% of the employee’s pre-tax deferrals that do not exceed 3% of compensation.
Another important difference is that under a SIMPLE plan, the employer may not make any additional contributions other than the 2% employer contribution or the matching contribution. Finally, an employer with a SIMPLE plan cannot make contributions to retirement plans other than the SIMPLE plan. An employer with a safe harbor 401 (k) plan may make additional contributions and may maintain other retirement plans in addition to the safe harbor 401(k) plan.
Final Thoughts
The safe harbor 40 I (k) plan provides an employer the opportunity to maintain a 401(k) plan without many of the problems associated with the nondiscrimination tests. The key to success is designing the plan to meet both the employer’s and the employees’ goals. In addition, the plan should use an administration company that will provide accurate, efficient, and cost-effective services. We have the professionals available to help you achieve each of these objectives.
We offer specialized retirement planning services to professionals transitioning out of the corporate world/workforce and into their new lives as retirees. Learn more about our retirement services or contact us today to discuss your needs
