Safe Harbor 401k Plans

The Safe Harbor 401(k) Plan allows eligible employees to contribute a portion of their own salary to a Safe Harbor 401(k) Plan retirement plan. Employers contribute either matching or non-elective amounts to the plan on behalf of their eligible employees. Employer contributions are then tax deductible and employee contributions are excluded from income for Federal Income Tax purposes making this a very attractive plan.

A Safe Harbor 401(k) Plan is a very specific type of 401(k) plan that encourages employee participation and that provides the employer more leniency in setting up the plans, without concerns about discrimination in favor of their highly compensated employees. The Small Business Job Protection Act of 1996 provided for this new type of 401(k).

Defined contribution plans, like regular 401(k) plans, must comply with IRS requirements to avoid discriminating in favor of some highly compensated employees (HCE's) with "top heavy" plans (paying these HCE's more as a percentage of pay than other employees). In a Safe Harbor 401(k) plan, all of the contributions must be fully vested immediately, The employer also must provide appropriate notice to employees about their rights under the plan.

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MOST COMMONLY ASKED QUESTIONS ABOUT SAFE HARBOR 401(k) PLANS

1. What is a Safe Harbor 401(k) Plan?

2. What employer contributions, if any, are required by the Safe Harbor 401k Plan?

3. How does the dollar for dollar match up to 4% of the employee's pay work?

4. How does the flat 3% of the employee's pay contribution work?

5. What is the timing of the employer's contribution?

6. What is the timing of the employee's contribution?

7. May the employer make additional contributions in a Safe Harbor 401(k)?

8. What are the vesting schedule and eligibility requirements in a Safe Harbor 401(k)?

9. How much can employees contribute into their Safe Harbor 401(k)?

10. What happens if an employee also has a tax deductible IRA plan elsewhere?

What is a Safe Harbor 401(k)?

 The Safe Harbor is essentially a Regular 401(k) plan that uses a prescribed contribution and vesting structure. By using these IRS-approved provisions, the plan falls under a “safe harbor”, which means that it automatically satisfies requirements for top-heaviness, deferral percentages, and owners’ contributions. This, in turn, means that it is less expensive and less complicated to administer.

What employer contributions, if any, are required by the Safe Harbor?

 In a Safe Harbor 401(k), the employer must make at least one of the following contributions from year-to-year:

I. A dollar-for-dollar match up to 4% of the employee’s pay. --OR--

II. A flat 3% of the employee’s pay.

How does the dollar-for-dollar match up to 4% of pay work?

 The dollar-for-dollar match up to 4% of pay contribution is dependent on what the employee contributes. Because it is a “match,” an employee not contributing would receive no employer contribution. Likewise, because it is “dollar-for-dollar,” if an employee contributed 2% of pay, s/he would receive a 2% of pay employer contribution (the employer matches the employee). The 4% comes in as a cap. So if an employee contributes 10% of pay, the employer would contribute 4% of pay. In other words, the most that the employer would be responsible for is 4% of payroll. Some examples are as follows:

Employee contributes 0%, the employer would contribute 0%.

Employee contributes 2%, the employer would contribute 2%.

Employee contributes 4%, the employer would contribute 4%.

Employee contributes 6%, the employer would contribute 4%.

Employee contributes 10%, the employer would contribute 4%.

How does the flat 3% of pay contribution work?

 Instead of doing the dollar-for-dollar match up to 4% of pay as described above, an employer may opt to contribute a flat 3% of pay on behalf of all eligible employees. Regardless of what the employee contributes (i.e., 0%, 4%, or 10%), the employer contributes 3% of pay.

What is the timing of the employer contribution?

The employer may choose to do either the matching up to 4%, or the flat 3%, on a year-to-year basis. The election to do so may be done later in the year retroactively, provided enough notice is given to employees. Most employers provide their contribution with every payroll, paralleling the time period that the employee contributes. However, the employer may choose to make a one-time contribution towards the end of the year instead.

What is the timing of the employee contribution?

Because the 401(k) plan uses salary deferrals, employee contributions normally take place per payroll period. The employer must deposit the employee contributions into the 401(k) plan within 30 days after the date of the deferral. For example, if an employee had withheld 10% of pay from his 12/15/08 paycheck, the 10% contribution must be deposited before 01/14/09.

May the employer make additional contributions in a Safe Harbor 401(k)?

Yes, the employer may make a ‘profit sharing’ contribution in addition to the contribution described above. The profit sharing contribution is usually expressed as a percentage of an employee’s annual pay, and is typically done once towards the end of the year. However, profit sharing contributions may be made more frequently, and are discretionary from year-to-year. The profit sharing contribution may be as little as 1%, or as high as 21% of pay. It may be integrated with the Social Security Wage Base, and offered on a vesting schedule.

What are the vesting and eligibility requirements in a Safe Harbor 401(k)?

Employee contributions (i.e., deferrals) are always 100% vested. In addition, the employer Safe Harbor 401(k) contribution (i.e, the 3%, or 4% match), is also 100% vested. An employer profit sharing contribution may be offered on an approved vesting schedule. Generally, the employer has the option of excluding employees who are under the age of 21, have less than 18 months of service, or work 500 or fewer hours per year.

How much can employees contribute into a Safe Harbor 401(k)?

An employee may contribute up to $14,000 in 2005. Employees who are age 50+ may contribute an extra $4,000. The dollar limit is scheduled to increase over the next 5 years. The amount that an employee contributes is in addition to the employer’s contribution(s) described above. Owners and principals may contribute up to this full dollar limit without regard to how much other employees are contributing. There is no longer a percentage limitation on how much an individual may contribute into the plan.

What happens if an employee also has a tax deductible IRA plan elsewhere?

Depending on their income, most employees will be unable to make both a 401(k) contribution and a deductible IRA contribution for any given year. Employees may contribute to a non-deductible, or Roth, IRA in the same year that they participate in a 401(k) plan. Regular IRA balances may now be rolled over into the Safe Harbor 401(k) to consolidate retirement accounts.

Business of any size can also adopt Safe Harbor 401(k) Plans. This type of retirement plan is similar to the traditional 401(k), except that the business owners have to make matching contributions to the plan. However, businesses do not have to abide by any non-discrimination rules that require annual testing.

Employers can match contributions dollar-for-dollar up to 3 percent of an employee's income under the safe harbor 401(k) plan. If an employee makes contributions beyond 3 percent, employers match 50 cents to every dollar that the employee contributed, up to 5 percent of the employee's income. You must contribute at least 3 percent of an employee's income to a safe harbor 401(k)plan, even if the employee does not make any contributions.

Employers who offer a safe harbor 401(k) plan must also notify the eligible employees about the plan every year, describing the safe harbor 401(k), how to make contributions and other details about the Safe Harbor 401(k) Plan.