In the United States, the most common type of retirement plan is the trusty 401(k). With over 60 million active participants and an estimated $7.3 trillion in assets, businesses of all sizes offer this type of plan to help their employees save for the retirement they deserve.
However, not all 401(k)s are the same. While offering any retirement plan can be a huge benefit, a “safe harbor” 401(k) plan can be a particular win-win. Safe harbor plans can maximize a company’s tax savings and retain employees, all while simplifying responsibilities for the employer.
Safe Harbor 401(k) Plans - The BasicsWhat is a Safe Harbor 401(k)?Like a traditional 401(k), a safe harbor plan gives employees access to a tax-advantaged savings and investment account. Generally, contributions to this account are automatically withdrawn from an employee’s paycheck and invested into funds of the employee’s choosing. However, the key difference between a traditional and a safe harbor 401(k) is in the employer contribution: With a safe harbor plan, the employer is required to make contributions and contributions become fully vested when made. Contributions can either be limited to employees who make deferrals or offered to all eligible employees.
How Do Small Businesses Benefit From Safe Harbor Plans?When 401(k) plans were first introduced, a central goal of the program was to ensure as many employees as possible participated, and that businesses didn’t disproportionately favor their highly-compensated employees when making employer contributions. As a result, traditional 401(k) plans are subject to what’s called “non-discrimination testing,” a form of compliance auditing that ensures the average contributions of highly paid employees does not exceed those of everyone else by more than 2%.
If the thought of this added paperwork turns you off, then a safe harbor plan may be for you.
Unlike traditional 401(k) plans, safe harbor plans automatically pass a number of required tests that keep the plan tax-qualified and avoid other penalties and costs. For this reason, safe harbor plans can be a great choice for small businesses that could have trouble passing nondiscrimination testing. For example, a family-owned or small business with more highly compensated employees relative to "rank and file" or non-highly compensated employees may otherwise have difficulty passing compliance tests.
How Do Employer Contributions Work in a Safe Harbor Plan?There are three “categories” of employer contributions that a business can choose to commit to when designing its safe harbor plan. These include:
More Good News About Safe Harbor PlansSECURE Act Tax Credits - Save Up to $16,500Thanks to the 2019 SECURE Act, small businesses can receive a tax credit as high as $16,500 for starting a new, qualified retirement program—which includes a safe harbor 401(k).
The tax credit is equal to $250 for each non-highly compensated employee (NHCE) who is eligible to participate in the plan, with a minimum credit of $500 and a maximum credit of $5,000, for three years. Additionally, if a business adds an auto-enrollment feature to your plan, known as an eligible automatic enrollment arrangement (EACA), they can claim a tax credit of $500 per year for a three-year taxable period. However, they must notify employees of the auto-enrollment feature and withhold wages from automatically enrolled participants at the plan’s default deferral rate.
How Business Owners BenefitSafe harbor plans are available to everyone at a company, including business owners who work for their company. These employers can contribute the maximum annual deferral amount to their own 401(k) plan, which is $20,500 for 2022 plus any catch up contributions. Further, come tax time, employers will be able to minimize their business’s expenses by deducting applicable employee and employer matching contributions from the company. Because many owners pay themselves out of their company’s profits, these savings can directly improve their bottom line.
There is Still Time to Maximize the Savings for 2022Safe harbor plans must be in effect three months prior to the plan year-end date, which means eligible employees must be able to make salary deferrals starting no later than the first pay date on or following October 1. Businesses interested in offering a safe harbor 401(k) plan should gear up to act soon: Leave time to get your plan up and running so you can give employees long enough to make elections before their first payroll.
Dates to Know for Switching to a Safe Harbor PlanIf you already have a different type of plan, no worries at all. You can always amend your offering to take advantage of safe harbor benefits, but there are some important dates to know: