Pros and Cons of Safe Harbor and Traditional 401(k) Plans

Both types of plans can successfully help employees save for retirement, but each has its pros and cons. Learn which type of plan might be better for your organization.

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Employers who are considering offering a 401(k) plan must balance how to help employees save for retirement in a cost-effective manner with the critical administrative considerations including how to ensure the plan operates in a compliant manner and retains its tax-qualified status. At a high level, there are two types of 401(k) plans: the Safe Harbor 401(k) Plan and the Traditional 401(k) Plan.

Both types of plans can successfully help employees save for retirement, but each has its pros and cons. Learn which type of plan might be better for your organization.

Traditional 401(k) Plans

Traditional plans can be cost-effective but must pass certain testing mandated by the IRS.


  • Employee Incentive - A 401(k) plan is one of the most important benefits that employees look for while exploring their career options. And it comes with significant tax advantages in helping employees save for their future.
  • Cost-Effectiveness - Because there are no required employer contributions, traditional plans may be more cost-effective for the company.
  • Discretionary Contribution - Plan sponsors can decide to match employee contributions or make profit sharing contributions on a discretionary basis, which provides significant flexibility. Each year, employers can choose how much they would like to contribute, or whether they want to contribute at all.


  • Required Annual Testing - Traditional plans are subject to all compliance tests, including the ADP, ACP and top heavy determination. If one or more of these tests fail, the plan sponsor is subject to corrective actions which can include additional contributions on behalf of the employees.
  • Limits of Contributions for Employees - Because of the ADP test, highly-compensated employees (HCEs) may not be able to maximize their 401k contributions. If HCEs do contribute the maximum amount, and the plan fails the ADP test, required refunds may increase taxable income for certain HCEs.
  • Administrative Burden - The required tests and possible failures may lead to uncomfortable conversations with employees who are impacted by such failures. They will need to understand why they are receiving refunds of their contributions and may not be able to maximize their 401(k).

Safe Harbor 401(k) Plans

Safe Harbor plans may be a better choice for employers looking for ways to bypass certain compliance tests. In return for the “safe harbor” status, employers are required to make employer contributions.


  • Annual testing exemption — A safe harbor plan will be automatically deemed to pass some of the crucial compliance tests such as the ADP and ACP tests, as well as the top-heavy test.
  • Maximize contributions  — Because they can bypass certain compliance tests, everyone in the plan can maximize their contributions to the allowable IRS limits, without having to worry about refunds.
  • Taxable income reduced — Employer contributions made as part of the Safe Harbor plan design are tax-deductible, reducing the employer’s taxable income.
  • Improved employee retention — The required mandatory employer contributions mean the 401(k) plan will be an attractive benefit to employees, which can help attract and retain talent and encourage healthy plan participation.


  • Cost of annual contributions — Safe Harbor plans require mandatory employer contributions on behalf of employees. The employer must be able to provide these contributions every pay period or at the end of the plan year. Failure to do so may result in the plan losing its tax-qualified status.
  • Immediate vesting requirement — Safe harbor contributions must be immediately vested. Once an employer contribution is deposited into an employee’s account, the employee is 100% owner of that money.
  • Annual requirements — A  Safe Harbor notice must be delivered to all plan participants every year, at least 30 days prior to the plan year-end.

What is the deadline to adopt a safe harbor 401(k) plan for the 2021 plan year?

If you are looking to implement a safe harbor plan for the 2021 plan year, it must be live by October 1, 2021. Sign up with Betterment by August 2, 2021 to start reaping the benefits of a safe harbor plan this plan year!

Which to choose: Traditional or Safe Harbor 401(k)?

The “right” plan for any given organization depends on many factors. The table below provides some insight into which plan design may be more helpful for any given factor, but each organization will need to make its own determination. Betterment is happy to assist with this process.

Traditional Safe Harbor Explanation
Employee Count 30 + employees Any plan size With few employees, even a small number of HCEs contributing at a relatively high level may make it difficult for plans to pass testing. In addition, the required employer contribution may be more manageable.
Employee Demographic
  • Employee base consists largely of full-time employees;
  • Low turnover rate
  • Stable headcount
  • Employee base includes a large number of part-time and/or seasonal employees working <500 hours a year
  • Part-time/seasonal employees are excluded from the plan
Safe Harbor plan design is helpful if the employee base is more fluid, which may make it more difficult to ensure the plan will pass testing each year.
Participation High (current or expected) participation and contribution rates among the general employee population Owners and officers looking to maximize 401(k) contributions every year With Safe Harbor, owners and offers can maximize contributions without having to worry about potential refunds.
Company Cash Flow Less predictable cash flow year over year Consistent and adequate cash flow Since Safe Harbor plans require employer contributions, consistent and adequate cash flow is needed.
Previous Compliance Result
  • Passed ADP/ACP Test
  • Deemed not “Top Heavy”
  • Failed ADP/ACP Test
  • Deemed “Top Heavy”
Safe Harbor plan design bypasses certain compliance tests, so “failing” them is no longer a concern.
Current/Future Plan Design
  • Strict eligibility requirements (i.e. must work 1,000 hours in 12 months to become eligible);
  • No automatic enrollment (or if offered, low default rate)
NHCEs contributing at relatively low contribution rates (or not contributing at all) do not cause issues under Safe Harbor plan design.