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Retirement Plans Blog

Safe Harbor Plans: Does Your 401(k) Need To Be One?

[fa icon="calendar"] Jun 29, 2015 9:00:00 AM / by Ken Ruthenberg

Ken Ruthenberg

Does your Code section 401(k) plan keep failing the nondiscrimination tests? Or are your highly compensated employees (HCEs) unable to defer as much as they would like because of the low level of deferrals by the nonhighly compensated employees (NHCEs)? If so, you should consider as one of your alternatives adopting a "safe harbor" plan where the deferrals do not have to be tested for nondiscrimination and the HCEs can defer up to the maximum dollar amount allowable. We have described the traditional two safe harbor plan alternatives below, along with some additional options that are seldom mentioned or utilized.

Nonelective Contribution Safe Harbor

The nonelective contribution safe harbor requires that the employer make a nonelective contribution to the plan (or another defined contribution plan) equal to at least 3% of compensation of each NHCE who was eligible to defer under the plan. There can be no additional requirements imposed on these NHCEs such as being credited with at least 1,000 hours of service during the year or being employed by the employer on the last day of the plan year (although see below for a twist on this approach). The NHCEs must be immediately 100% vested in this contribution.

Matching Contribution Safe Harbor

The matching contribution safe harbor requires that the employer make a matching contribution to the plan (or another defined contribution plan) equal to 100% of each NHCE's deferrals up to 3% of compensation and 50% of each NHCE's deferrals between 3% and 5% of compensation. Alternatively, the employer may make a matching contribution equal to 100% of each NHCE's deferrals up to 4% of compensation. In addition, the matching contribution safe harbor requires that the rate of employer matching contributions for any HCE, at any rate of deferrals, cannot be greater than the rate of employer matching contributions provided to the NHCEs. As with the nonelective contribution safe harbor, the NHCEs must be immediately 100% vested in this contribution.

Can the employer match deferrals in excess of 5% of compensation? Yes; however, if an employer matches deferrals in excess of 6% of compensation, the safe harbor will no longer apply to the matching contributions portion of the plan and the employer matching contributions will have to be tested (although the safe harbor would still apply to the deferrals portion of the plan).

Other Alternatives

The wait-and-see safe harbor is a variation of the nonelective contribution safe harbor. It seems to be seldom mentioned or utilized, perhaps because it is a little more difficult to understand and requires extra work. Under the wait-and-see safe harbor, the employer waits until near the end of the plan year to decide whether the plan is going to be a nonelective contribution safe harbor plan for the plan year – typically by running preliminary nondiscrimination tests for the plan year. If the employer decides to make the plan a safe harbor plan for the plan year involved, the employer must, no later that 30 days before the end of the plan year, (i) give a safe harbor notice to the employees (see below) and (ii) amend the plan to be a safe harbor plan for that entire plan year. See Automatic Enrollment – Time To Plan And Act, or adopting a simple 401(k) plan if you are a small employer (although such a plan might not be as simple as it sounds – see A More SIMPLE Way?).

Safe Harbor For Only Some Employees

It is possible to provide the safe harbor for only some of the participants, and to perform nondiscrimination testing for the other participants, without violating the safe harbor rules depending on the plan's eligibility requirements. This alternative plan design is possible because of the rules that allow a plan that benefits otherwise excludable employees (e.g., those who have not completed one year of service) to be disaggregated for testing purposes into two plans: one for the otherwise excludable employees and one for the other employees. For example, if the plan provides that all employees are eligible to defer compensation, with no minimum service requirement, then the plan could be disaggregated (for testing purposes only – still just one plan) into one plan for employees who have not yet completed one year of service – these employees would not be subject to the safe harbor provisions – and one plan for the employees who have completed one year of service – these employees would be subject to the safe harbor provisions. This approach may work well if the employees who have not yet completed one year of service include no HCEs.

Notice Requirements

Regardless of which approach is used, the employer must notify its employees about the safe harbor being used (or possibly used under the wait-and-see alternative) before the beginning of the plan year involved (at least 30 days in advance). Additional notice is required if the employer uses the wait-and-see alternative – as indicated above, the employer must notify the participants if the nonelective contribution safe harbor is going to be used at least 30 days before the end of the plan year involved.

The employer must also make sure that the plan document contains the appropriate safe harbor provisions before the beginning of the plan year involved. In the case of a employer that uses the wait-and-see alternative, the plan must be amended to provide for the nonelective contributions at least 30 days before the end of the plan year involved.

Top-Heavy Plan Considerations

If a plan consists solely of the employees' deferrals and the safe harbor contributions, the plan is not subject to the top-heavy plan rules. If the plan is subject to the top-heavy plan rules, the employer's safe harbor contributions count towards the top-heavy plan minimum contribution requirement.

Cautions

An employer should not make the decision to have a safe harbor plan lightly. Once made, the decision may be difficult to undo because the rules prohibit a plan from ceasing to be a safe harbor plan once the plan year is underway except in limited circumstances (another reason for why the wait-and-see alternative may be appealing).

What To Do

If you are considering adopting a safe harbor plan, you should work with your third party administrator and your benefits counsel to determine if doing so is appropriate for your situation and, if so, which approach suits you best. Remember, no matter which approach you take, you need to start planning well in advance of your upcoming plan year so that you can give the appropriate notices and have the appropriate documents in place well before the beginning of the next plan year.

Ken Ruthenberg

Written by Ken Ruthenberg