When to set sail with safe harbor

The IRS put in place rules to assure your plan benefits rank and file employees and not just company owners and highly compensated employees.

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 three tests that must be performed each year to determine whether your plan measures up.

Here they are in a nutshell:

  1. The Actual Deferral Percentage (ADP) test looks at how the deferral rate for highly compensated employees compares to that of non-highly compensated employees. Typically, the deferral percent for highly compensated employees can't be more than two points more than that of the non-highly compensated employees to pass this test.
  2. The Actual Contribution Percentage (ACP) test compares employer matching contributions between these two groups.
  3. The Top-Heavy test determines if the account balances of key employees is greater than 60% of the total assets held by the plan.

We know that the goal of many company owners is 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.

You can make a Safe Harbor contribution either through a matching formula, or by making a non-elective contribution to all of your employees. Let's take a quick look at ways to do this:

Safe Harbor Match
To satisfy the requirement and encourage plan participation, you may choose to offer a Safe Harbor Match. The Basic Match formula provides a 100% match on the first 3% of deferral compensation, plus a 50% match on deferrals between 3% and 5%.

Enhanced Match
An Enhanced Match has to be at least as much as the Basic Match at all levels and is typically a match of 100% on the first 4% of deferral compensation.

Non-Elective Contribution
Matching or non-elective contributions represent additional competitive benefits to help recruit and retain employees.

The other Safe Harbor option is to make a contribution of at least 3% of annual compensation for all eligible employees including those employees who don't defer.

A quick note: Safe Harbor contributions must always be 100% vested. That means employees can count these contributions in their balances without forfeiture upon termination of employment.

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
  • Its matching or nonelective contributions represent additional competitive benefits for employees

Questions?

We encourage you to contact Brad Bechtel using the information below to learn more about how Safe Harbor contributions can help make your plan more successful.

Brad Bechtel

Senior Vice President
Employee Benefit Services

Brad Bechtel leads AGH’s employee benefit services (EBS) division, which serves clients nationwide. EBS is one of the region's largest providers of retirement plan recordkeeping services for daily valuation plans. The division provides consulting services to clients on employee benefit plans, including plan design, implementation, operation, fiduciary due diligence, compliance, and through affiliate AGH Wealth Management, discretionary and non-discretionary investment fiduciary services, investment advisory services and employee education.

Bechtel is experienced in executive compensation, including non-qualified, phantom stock, top hat and excess benefit plans, as well as other deferred compensation approaches. He has consulted for numerous Fortune 500 corporations on investment management and fiduciary due diligence. He also provides search and selection due diligence consulting services for companies seeking new investment and recordkeeping providers for their qualified plans. Bechtel is a registered investment advisor who holds Series 7, 24 and 66 FINRA registrations, and he is a member of the American Society of Pension Professionals & Actuaries.

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