What is a safe harbor 401(k) plan? | Maillie LLP

What is a safe harbor 401(k) plan?

Edward Fronczkowski, CPA, Partner


A safe harbor 401(k) plan is a plan that ensures all employees have some minimum contribution made to their individual 401(k) plans.  They are generally simpler to maintain because they are exempt from some or all of the complicated testing requirements that normally apply to traditional 401(k) plans. To qualify as a safe harbor plan, a 401(k) plan must meet special notice, contribution, vesting, and distribution requirements.

In a traditional 401(k) plan you can, but you are not required to, make employer contributions. With a safe harbor plan, you must make a fully vested contribution under one of three funding options. First, you can contribute 3% (or more) of pay for each employee eligible to participate in the plan. This "nonelective contribution" must be made even for participants who aren't actively contributing.

Second, as an alternative, you can match employee contributions to the plan. If you use this approach, you must match each employee's contributions dollar for dollar up to 3% of that employee's pay, and match contributions from 3% to 5% at a 50% rate (the "basic match"). Third, you also have the option of making an "enhanced" matching contribution that's at least as generous as the basic match, and that meets other requirements.

Your safe harbor contributions are generally subject to the same withdrawal rules that apply to employee 401(k) deferrals (that is, payouts are only allowed upon termination of employment, disability, death, hardship, or after age 59½).

By using a safe harbor plan you may be able to avoid most of the annual compliance tests.  A safe harbor plan will automatically satisfy the "actual deferral percentage" (ADP) test that compares the average deferrals of your higher-paid and lower-paid employees. This test often limits the amount that your higher-paid employees can defer into the plan. If you make the basic safe harbor matching contribution, you will automatically satisfy the "actual contribution percentage" (ACP) test that applies to matching contributions. If you make additional matching contributions (including the enhanced match), you will avoid ACP testing if you don't match employee contributions over 6% of pay, and any discretionary matching contributions don't exceed 4% of pay. Finally, you will avoid top-heavy testing if you make only the safe harbor contribution to the plan.

You do not have to use the safe harbor rules every year. But for any year you do want to use a matching safe harbor treatment, you must provide a notice to employees at least 30 days before the plan year starts. The notice must tell employees you will be using the safe harbor rules for the following year, describe the safe harbor contribution you will make, and explain the employees' rights and obligations under the plan.

You can also have a "flexible" safe harbor plan that lets you decide as late as 30 days prior to the end of a plan year whether you will use the 3% nonelective safe harbor for that year. You might find this plan design useful if you want to see how your discrimination testing is progressing before you commit to a safe harbor contribution for the year. Alternatively, the SECURE Act now allows a plan to be amended as late as the end of the year following the plan year, but only if the nonelective safe harbor contribution is 4%.

A qualified automatic enrollment arrangement (QACA) is a 401(k) plan with an automatic enrollment feature that avoids ADP, ACP, and top-heavy testing that meets certain requirements. While most of the rules applicable to safe harbor plans also apply to QACAs, there are some notable exceptions. Under a QACA, an employee who fails to make an affirmative deferral election is automatically enrolled in the plan. An employee's automatic contribution must be at least 3% for the first two calendar years of participation and then increase 1% each year until it reaches 6%. You can require an automatic contribution of as much as 15%. Employees can change their contribution rate, or stop contributing, at any time (and get a refund of their automatic contributions if they opt out within 90 days).

As with safe harbor plans, you are required to make an employer contribution; either 3% of pay to each eligible employee, or a matching contribution, but the match is a little different — dollar for dollar up to 1% of pay, and 50% on additional contributions up to 6% of pay. You can also require two years of service before your contributions vest (compared to immediate vesting in a safe harbor plan). And if you select certain default investments to hold employees' automatic contributions, you'll generally be relieved of fiduciary responsibility for any losses your employees incur while in those investments.

A QACA may be an attractive alternative to a regular safe harbor plan if you like the idea of automatic enrollments.

If you have any questions, please contact your Maillie representative for more information.