Unlike traditional plans, safe harbor plans are exempt from annual nondiscrimination testing. This benefit is essential for company owners and highly compensated employees, who might otherwise see their ability to make a maximum contribution curtailed by the test.
If you want a 401(k) plan that simplifies compliance, schedule a free consultation with Vestwell today!
With traditional 401(k) plans, companies must pass nondiscrimination testing to ensure that highly compensated employees (HCEs) benefit similarly to non-HCEs. These tests can be costly and complex to manage, especially for smaller businesses. Safe harbor 401(k)s are an excellent option for small businesses because they allow you to provide your employees with the same tax advantages of a traditional 401(k) plan without the need to pass annual compliance testing.
Using a safe harbor plan, your business can offer a simple employer match or nonelective contribution of up to 4% of pay, with no requirement to fund a top-heavy contribution for HCEs. You may limit your employer matching or nonelective contributions to those who make elective deferrals, or you can expand the offering to all eligible employees.
Safe harbor plans are cost-effective if you expect most of your workforce to participate and contribute. This is why you’ll want to carefully analyze your compensation levels, savings rates, and participation rates before choosing a plan design.
Fortunately, with new legislation such as the SECURE Act of 2019, employers now have greater flexibility to design a safe harbor plan that works best for your business. However, there are still some important rules to follow to ensure you comply with the IRS’s safe harbor regulations.
Ease of Administration
In addition to being more accessible for small businesses to operate, Safe Harbor 401k plans are also less expensive than traditional retirement plan options. With a traditional 401(k), the company must pay into each employee’s account according to their contribution limits and invest those funds. The 401k contributions are pre-tax. The business must meet IRS nondiscrimination tests every year. However, with a safe harbor 401(k), the employer is exempt from these tests.
If your company is considering offering a safe harbor plan, you should speak to an accountant or financial advisor to learn more about the rules and requirements. Employees must receive written notice of plan changes before contributing. Additionally, the company must set up a safe harbor match and provide a minimum of 4 percent non-elective contribution into each employee’s account.
The good news is that the company will save money on taxes, and employees can invest their contributions into mutual fund options. The investments in a safe harbor plan grow tax-free until withdrawal, typically at retirement or leaving the workforce. This plan also aids in attracting and retaining top talent. A study by 401(k) Specialists found that employees are more likely to stay with a company if it offers a retirement savings program. This is especially true if the company provides a Safe Harbor plan.
Attract and Retain Top Talent
Offering a retirement plan is a crucial way to attract and retain employees. However, it is essential to note that the IRS requires annual nondiscrimination tests to ensure that the company’s plan does not favor highly compensated (HCE) employees. Failing these tests can be costly and time-consuming. Safe Harbor 401(k) plans provide an excellent solution to this problem. These plans are designed to avoid the need for annual nondiscrimination testing. This allows the business to contribute a minimum amount to all non-HCE employees’ 401(k) accounts.
The combination of these features makes Safe Harbor 401(k) plans ideal for small businesses that need to attract and retain top talent in a competitive workforce. In addition to offering significant tax savings for employers, these plans are an effective tool to keep the company’s workforce engaged and happy.
While Safe Harbor 401(k) retirement plans are an excellent choice for most businesses, it is important to consider the needs and goals of each company. If you’re considering a Safe Harbor 401(k) plan, we recommend consulting with a financial advisor for more information. Other alternative retirement plans include individual 401(k)s, SIMPLE and SEP IRAs, and profit-sharing plans. Every plan comes with its advantages and disadvantages. We are happy to help you decide which option is best for your needs.
Maximize Your Contributions
An attractive retirement plan can help your company attract top-tier talent, which can be critical in a tight labor market. Additionally, the safety of a Safe Harbor 401k can encourage your employees to contribute more to their retirement plan, which can boost their financial wellness and increase their overall satisfaction with their employer.
Moreover, a Safe Harbor plan allows highly compensated employees (HCEs) to maximize their salary deferrals without worrying about limiting their contributions by government testing. While a regular 401(k) must pass nondiscrimination testing to avoid the return of excess contributions or mandatory corrective employer contributions, a Safe Harbor 401(k) is exempt from this test.
Employees can elect to save up to $22,500 of their pre-tax or post-tax salary and can also make an additional $7,500 in catch-up contributions. This limit is indexed annually by the IRS. With a Safe Harbor plan, employers can provide either nonelective or matching contributions.
As with other retirement plans, the total cost of a Safe Harbor plan is based on several factors, including compensation levels, savings rates, and participation rates. In general, the lower the compensation levels and saving rates, the less costly the Safe Harbor contributions will be. Employers can control their costs by choosing a formula that is less costly for them, such as a 4% Safe Harbor Match or a simple nonelective contribution of 3% of each eligible employee’s salary.