You already know that a 401(k) is a very popular retirement plan and, like other plan designs, it allows your employees to take advantage of tax deferrals on contributions and earnings while their money accumulates for retirement. To enjoy this special status, the IRS put in place rules to assure your plan benefits rank and file employees and not just company owners and highly compensated employees. These are called nondiscrimination rules and there are tests that must be performed each year to determine whether your plan measures up.
We know that as a company owner your goal may be to maximize how much you can contribute each year to your retirement. So, to avoid uncertainty about this, you can choose to make additional contributions for your employees in order to get a free pass on these non-discrimination tests. These are called “Safe Harbor” contributions.
There are several matching formulas or non-elective contributions an employer can make to satisfy a safe harbor requirement. In this short chat, we’ll talk about an option the IRS introduced that does this and that encourages greater plan participation. It’s called a Qualified Automatic Contribution Arrangement or QACA for short! It’s a funny name, but it’s become a very popular Safe Harbor design because it encourages more people to save for their future.
Here are five quick, but important things to know about how it works:
- Your plan must automatically enroll any eligible employee unless they choose to opt out.
- Employee deferrals start automatically at a minimum of 3% of compensation unless they change this, and this rate increases 1% each year until it reaches at least 6%.
- The plan must also include a qualified default investment for employees who don’t make an investment election on their own.
- The matching contribution formula for a QACA Safe Harbor Plan is a 100% match on the first 1% of compensation deferred and a 50% match on deferrals between 1% and 6%. [3.5% total]
- And, unlike other safe harbor options, the match can be subject to a 2-year cliff vesting schedule. That means if an employee leaves the company inside of two years, they forfeit the match back to the plan.
This plan design encourages automatic enrollment and automatic increases to put more people on a savings path and gives employers more flexibility as well.
Adopting a Safe Harbor provision can help your plan in four important ways:
- It can potentially reduce plan maintenance costs by eliminating annual nondiscrimination testing requirements
- It allows you and other highly compensated employees to maximize your deferral to the annual limit
- It relieves your plan’s potential top-heavy status, and
- The matching or nonelective contributions represent additional competitive benefits to help recruit and retain employees