Employees, Sponsors Sailing Toward Safe Harbor 401(k) Plans

Just the name sounds tranquil... "safe harbor 401(k) Plans." And that's no accident. Understanding and meeting the nondiscrimination requirements of standard 401(k) plans can be daunting. Safe harbor plans are relatively new, which has caused some to watch from the sidelines to see how they work out.  

Both standard 401(k) plans and safe harbor plans allow eligible employees to redirect part of their salaries into retirement plans. With standard plans, nondiscrimination rules limit how much highly compensated employees can contribute to their own accounts. On the other hand, as long as certain requirements are met, a safe harbor plan makes it possible for employees to max out their retirement contributions.

The Hurdles to Clear

Actual contribution percentage, and actual deferral percentage: To satisfy these requirements, your company has to make contributions for your employees, and remove vesting restrictions on those contributions.

The employer contribution requirement can be satisfied in one of two ways. One option (actual percentage contribution) is to make matching contributions into the account of every non-highly compensated employee who elects participation. You must match 100% of at least the first 3% of the employee's compensation, and 50% of the employee's own contributions, up to a maximum of 5%.

The other option (actual deferral percentage) is to use an enhanced matching formula where the rate is non-increasing.  For this option, the aggregate match must equal the basic matching formula, such as 100% match on deferrals to a maximum of four percent of compensation. This plan requires that the employer makes a flat, non-elective contribution to the account of each non-highly compensated employee who is eligible to participate, even if he or she chooses not to contribute. The employer's contribution must be for three percent of the employee's yearly compensation.

What are your restrictions for contributions to highly compensated employees? Whether you choose actual contribution percentage or actual deferral percentage, you can contribute similarly to the accounts of highly compensated employees. The key is, the match you give to these employees cannot be higher than the match for non-highly compensated employees.

Here are some points to consider in analyzing the potential cost of implementing a safe harbor plan.

• How many employees do you have?
• What is the likely overall plan participation?
• Are you already making matching contributions or non-elective contributions to an existing plan?

You are, of course, responsible for the record-keeping and administration of your plan. You should know, if your company's financial situation worsens, you must still continue to make non-elective contributions, unless you cease contributions altogether. Taking this action must be preceded by 30-day notice for your employees. You will also have to do discrimination testing, and matching and non-elective contributions must fully vest to the employees.

If you decide to go forward with a safe harbor plan, the IRS requires that you provide employees with advance written notice, at least 30 days but not more than 90 days before the start of the plan year. Overall, the IRS says that a safe harbor plan offers greater flexibility of design, but it can also be more complex to set up and administer than some alternatives. Also, depending on the details of your plan, you may be required to do annual nondiscrimination testing and to file an annual return.