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A Guide to Safe Harbor 401(k) Plans

Stress less by setting up a Safe Harbor 401(k). You can bypass some of the tests and focus on helping your employees save for their financial futures.

Articles by Betterment Editors
By the Editorial Staff Betterment Resource Center Published May. 13, 2020
Published May. 13, 2020
6 min read

“Your 401(k) plan failed.” Those words can strike fear in the hearts of even the most seasoned business owners. However, there’s a way to avoid the stress of your plan’s annual nondiscrimination testing. By setting up a Safe Harbor 401(k), you can bypass some of the tests, such as the ADP and ACP tests, and focus on helping your employees save for their financial futures. But is a Safe Harbor 401(k) right for your company? Read on for answers to frequently asked questions about Safe Harbor 401(k) plans.

What is nondiscrimination testing?

Before we explore Safe Harbor plans, let’s talk about nondiscrimination tests. Mandated by ERISA, these annual tests help ensure that 401(k) plans benefit all employees—not just business owners or highly compensated employees (HCEs). Because the government provides significant tax benefits through 401(k) plans, it wants to ensure that these perks don’t disproportionately favor high earners.

The three main nondiscrimination tests are:

  • Actual deferral percentage (ADP) test—Compares the average salary deferrals of HCEs to those of non-highly compensated employees (NHCEs).
  •  Actual contribution percentage (ADC) test—Compares the average employer contributions received by HCEs and NHCEs.
  • Top-heavy test—Evaluates whether a plan is top-heavy, that is, if the total value of the plan accounts of “key employees” is more than 60% of the value of all plan assets. (IRS defines a key employee as an officer making more than $185,000, an owner of more than 5% of the business, or an owner of more than 1% of the business who made more than $150,000 during the plan year.]

Why is it hard for 401(k) plans to pass nondiscrimination testing?

It’s actually easier for large companies to pass the tests because they have many employees at varying income levels contributing to the plan. However, small and mid-size businesses may struggle to pass if they have a relatively high number of HCEs. If HCEs contribute a lot to the plan, but NHCEs don’t, there’s a chance that the 401(k) plan will not pass nondiscrimination testing.

So, you may be wondering: “What happens if my plan fails?” Well, you’ll need to fix the imbalance by returning 401(k) plan contributions to your HCEs or by increasing contributions to your NHCEs. If you have to refund contributions, affected employees may fall behind on their retirement savings—and that money may be subject to state and federal taxes! If you don’t correct the issue in a timely manner, there could also be a 10% penalty fee and other serious ramifications.

If you offer employees a Safe Harbor 401(k) plan, you can avoid these time-consuming, headache-inducing compliance tests.

What is a Safe Harbor 401(k) plan?

So, let’s back up for a minute. What exactly is a Safe Harbor 401(k) plan? Put simply, it’s a defined contribution retirement plan that’s exempt from nondiscrimination testing. It’s like a typical 401(k) plan except it requires you to contribute to the plan on your employees’ behalf, sometimes as an incentive for them to save in the plan. This mandatory employer contribution must vest immediately—rather than on a graded or cliff vesting schedule. This means your employees can take these contributions with them when they leave, no matter how long they’ve worked for the company.

To fulfill Safe Harbor requirements, you can elect one of the following general contribution formulas:

  • Basic Safe Harbor match—Employer matches 100% of employee contributions, up to 3% of their compensation, plus 50% of the next 2% of their compensation.
  • Enhanced Safe Harbor match—Employer matches 100% of employee contributions, up to 4% of their compensation.
  •  Non-elective contribution—Employer contributes 3% of each employee’s compensation, regardless of whether they make their own contributions.

These are only the minimum contributions. You can always increase non-elective or matching contributions to help your employees on the road to retirement.

What are the benefits of a Safe Harbor 401(k) plan?

At the end of the day, you want your employees to achieve the retirement they envision—and a Safe Harbor 401(k) plan can help them pursue it (while saving you time and effort). Consider these top five reasons to elect a Safe Harbor 401(k) plan:

  1.   Attract and retain top talent—Offering your employees a matching or non-elective contribution is a powerful recruitment tool. In fact, a recent Betterment for Business study found that nearly half of respondents said a company match was a factor in whether or not they accepted a new job. Plus, an employer contribution is a great way to reward your current employees (and incentivize them to save for their future).
  2.   Improve financial wellness—Studies show that financial stress impacts employees’ ability to focus on work. By helping your employees save for retirement, you help ease that burden and potentially improve your company’s productivity and profitability.
  3.   Save time and stress—Administering your 401(k) plan takes time—and it can become even more time-consuming and stressful if you’re worried that your plan may not pass nondiscrimination testing. Skip the tests altogether by electing a Safe Harbor 401(k).
  4.   Reward your top earners—With a Safe Harbor 401(k) plan, you can ensure that you and your HCEs will be able to max out your retirement contributions (without the fear that contributions will be returned if the plan fails nondiscrimination testing).
  5.   Reduce your taxable income—Like any employer contribution, Safe Harbor contributions are tax deductible! Plus, you can receive valuable tax credits to help offset the costs of your 401(k) plan.

An Ideal Solution for Small Businesses

If you’ve failed nondiscrimination testing in the past—or are concerned that your lower earning employees won’t participate in a 401(k) plan—a Safe Harbor plan may be the best solution for your small business.

Get a Safe Harbor 401(k) plan that works for you and your employees.

Get a Safe Harbor 401(k) plan with Betterment

What are the key cost considerations of offering a Safe Harbor 401(k) plan?

The main consideration is that Safe Harbor contributions could increase your overall payroll by 3% or more depending upon your participation rates and contribution formula. Therefore, it’s important to think about whether your company has the financial capacity to make employer contributions on an annual basis.

The good news is that 401(k) plans—including those with Safe Harbor provisions—are more affordable than they have been in the past. In fact, providers like Betterment now offer comprehensive plan solutions at low costs.

How do I set up a Safe Harbor 401(k) plan?

If you’re thinking about setting up a Safe Harbor plan, here are a few Safe Harbor 401(k) rules you need to know:

  •  Starting a new plan—October 1 is the final deadline for starting a new Safe Harbor 401(k) plan. But don’t cut it too close—you’re also required to notify your employees 30 days before the plan starts. So, if you’re mulling over a Safe Harbor plan, be sure to talk to your plan provider well in advance.
  • Adding a Safe Harbor provision to an existing plan—If you want to add a Safe Harbor provision to your current plan, you can include a plan amendment that goes into effect January 1. However, there’s also a 30-day notice requirement for employees.
  • Communicating with employees—Every year, eligible employees need to be notified about their rights and obligations under your Safe Harbor plan. Notice must be given at least 30 days, but no more than 90 days, before the beginning of the plan year. Want to learn more about notices? Visit the IRS website.

A plan provider like Betterment will be able to assist you with everything you need to start the Safe Harbor 401(k) plan that’s right for your company.

How do I select a Safe Harbor 401(k) plan provider?

When it comes to choosing the right provider, it’s all about asking the right questions. Here’s how Betterment would answer them:

  • Do you have experience setting up Safe Harbor 401(k) plans?
    • Our team has significant experience working with Safe Harbor 401(k) plans. We help you understand each step of the onboarding process so you can start your plan quickly and easily. Plus, we have the expertise you need to handle every detail—from Safe Harbor 401(k) eligibility rules to investment options.
  • How much does your service cost?
    • Our fees are a fraction of the cost of most providers. Plus, we’re always fully transparent about fees so there are no surprises for you or your employees.
  • How easy will it be for me to administer our plan on an ongoing basis?
    • Our intuitive platform works to reduce your administrative burden. That means you’ll stay informed of what you need to do and when you need to do it—simplifying plan administration.
  • Do you offer financial wellness support for employees?
    • Our high-tech solution enables us to give employees holistic, personalized advice on everything from contribution rates to investments. Plus, we link employees’ outside investments, savings accounts, IRAs, and spousal/partner assets, so they can get a big picture view of their long- and short-term financial goals.
Get a Safe Harbor 401(k) plan with Betterment

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