How Safe Harbor Plans Offer Flexibility to Employer 401(k) Plans

Safe harbor 401(k) plans offer plan sponsors an effective way to simplify compliance and enhance employee retirement savings opportunities. Including a safe harbor provision can bypass the challenges of annual nondiscrimination testing, which often negatively impacts highly compensated employees (HCEs). Failing these tests often means corrective distributions, where excess contributions are refunded, creating confusion and dissatisfaction in the workforce. Here, Meghan Hannon, CRPS®, CPFA®, Partner and Head of Retirement Plan Consulting, explains the potential benefits of rounding out your employer 401(k) plan with a safe harbor plan.

Testing Exemptions

One of the most significant advantages of a safe harbor plan is it allows for exemption from key nondiscrimination tests. These include the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, which compare contributions between HCEs and non-HCEs. Plans that fail these tests often require corrective actions, such as returning contributions to HCEs or increasing contributions for non-HCEs. Safe harbor plans are also generally exempt from top-heavy testing unless supplemental contributions, like profit sharing, are added. A safe harbor plan allows HCEs to maximize their contributions without the risk of refunds or additional liabilities by meeting these requirements.

Safe Harbor Contribution Requirements

Safe harbor plans require employers to make mandatory contributions to employees, which must be fully vested immediately. These contributions can take several forms, such as a basic match of 100% of the first 3% deferred and 50% of the next 2% or a 3% nonelective contribution for all eligible employees. A Qualified Automatic Contribution Arrangement (QACA) match, which matches 100% of the first 1% plus 50% of the next 5% of compensation. The total potential of a QACA match is 3.5% or a 3% nonelective contribution. Additionally, QACA contributions vest over 2 years rather than immediately. This approach maintains compliance while reducing contribution costs, offering flexibility for years when resources are tight. Consider consulting with an experienced retirement plan advisor to discuss these requirements and potential effects on an employer 401(k) plan.

Does a Safe Harbor Plan Make Sense for Your Plan?

Safe harbor plans offer attractive advantages for many businesses, particularly those facing specific challenges or opportunities within their existing 401(k) plan. They can be valuable for companies where HCEs are restricted from maximizing their retirement contributions due to failed nondiscrimination testing or where participation rates among non-HCEs are low. When compliance testing limits HCE contributions or requires corrective distributions, converting to a safe harbor design eliminates these concerns, allowing HCEs to maximize their deferrals confidently. They can also be a smart choice for companies that already provide matching or nonelective contributions, as the incremental cost of meeting safe harbor requirements may be minimal. In addition, the plan still maintains flexibility through discretionary profit-sharing contributions, allowing employers to provide additional benefits when financially feasible. However, these supplemental contributions must satisfy standard nondiscrimination testing requirements.

From an administrative perspective, safe harbor plans require sending annual notices to eligible employees at least 30 days before the plan year starts. While changes to plan provisions typically begin with a new plan year, employers can modify or suspend safe harbor provisions midyear in cases of economic hardship if proper notice is given. This administrative process, along with additional notices for automatic enrollment features (QACA), helps maintain clear communication and smooth operation of the plan.

Helping You Get There…

For plan sponsors, safe harbor 401(k) plans offer a practical way to balance regulatory compliance with flexibility. By eliminating testing concerns and ensuring HCEs can confidently maximize their contributions, these plans help create a stronger, more predictable retirement benefit. Whether exploring safe harbor options for the first time or seeking to refine an existing plan, consulting with experienced employer retirement plan professionals can help you navigate the rules and design a plan to support your company’s goals.