Safe Harbor 401k: Guide for Business Owners
Safe Harbor 401k’s are an increasingly popular option for small businesses. 401k plans in general offer the most flexibility to provide both a critical benefit for employee retention and significant tax savings to the owners.
What is a safe harbor 401(k) plan?
401ks are salary deferral plans that require a little effort and cost to establish, but are great tools for small businesses that are profitable. Employers are required to match these salary deferral contributions based upon rules established by Congress. These matching requirements come with several tests to ensure that the rules are followed to prevent discrimination in favor of the owners and highly compensated employees.
A Safe Harbor 401k is a provision in the rules to skip most of these testing requirements and allow owners and highly compensated employees to contribute the maximum allowed to the plans. The Safe Harbor rules essentially say, if employers contribute at least this much, they are free from the testing and limitations.
What are the Requirements of a Safe Harbor Plan Design?
The safe harbor provision has to be written into the plan document. For existing plans, this means amending the plan document, which will usually have a cost with your plan provider.
The safe harbor contributions have to be 100% vested for employees, unlike discretionary contributions.
For new plans, the deadline to make the change is October 1st of the plan year. This allows for the mandatory notifications to employees.
Contributions of the safe harbor match follow the same guidelines of discretionary contributions. Generally employers make the contributions with each payroll, but are not technically due until the filing date (including extension) of the tax year. Currently this is September 15th of the following year.
The Three Safe Harbor Match Contribution Formulas
These minimum contributions come in three different flavors. The most popular is matching 100% of the first 3% of compensation and then 50% of the next 2%. So the total employer contribution would be 4% if the employer contributed 5%.
The second option is to contribute 3% of compensation for all eligible employees, regardless of whether the employee contributes anything.
This option usually ends up being more than the first, but ultimately depends on how many employees participate.
The third employer contribution option is rarely used, but is worth noting. It is called QACA Safe Harbor. This option requires that all eligible employees be automatically enrolled in the plan. The employer match for QACA is 100% of the first 1% of compensation and then 50% of the next 5%. So if an employee contributes 6%, the maximum QACA contribution is 3.5%. This maximum amount is lower than the basic Safe Harbor match, but it requires that everybody be enrolled automatically. This will more likely than not mean a larger total employer contribution, since left to their own devices only half of employees participate in a 401k plan.
Safe Harbor 401(k) Contribution Limits for 2023
Salary deferral limits for 2023 are $22,500 or $30,000 for participants over age 50 and over.
The contribution to the plan will depend on employees participating, and which contribution formula you choose. Taking the most popular matching, you will could be making a employer safe harbor match of 4% of each participating employee. Although 100% participation in plans is rate, so your basic match will be likely lower.
Benefits of a Safe Harbor Provision
A Safe Harbor 401k plan has all of the same benefits of a “regular” 401k plan including:
Vesting schedule for non-Safe Harbor employer contributions
Participant Loans
Exclusion of employees under 21 years old, less than 1000 hours of service, or those covered under a collective bargaining agreement.
ROTH accounts, in addition to the traditional accounts.
Large discretionary employer matches up to $61k per employee based upon salary and age.
Disadvantages of a safe harbor 401(k) plan
The primary disadvantage of a Safe Harbor plan is that you are committing to making a contribution to your employees. That is the trade off to ensure that the owners can maximize their contributions.
For large employers, this may not provide enough juice of the tax savings squeeze. If you are only providing a 401k plan as an employee benefit, and are not interested in maximizing your contributions for owner's tax savings, then a safe harbor is fine, but probably unnecessary. If you have a lot employees participating in the plan, the owner's will probably pass the test requirements for contributions.
Conclusion
Safe Harbor plans are excellent tools to maximize tax savings and contributions for small business owners. You will need to carefully consider the tax savings with the additional employer contributions.
We’ve helped many small business owners maximize their 401k plans. Give us a call to see how we can help you!