Navigating Safe Harbor 401(k) Rules

September 7, 2017 1:25 PM
By Brian Dobbis

In order to meet important IRS guidelines, don’t forget that the deadline for new Safe Harbor plans is October 1.


With $5 trillion in assets, 401(k) plans continue to be one of the most popular retirement plan savings option for employers. They are eligible for a variety of employer and employee tax benefits. Moreover, a 401(k) plan also allows businesses to provide employees with a substantial retirement benefit, while offering a number of plan design options.   

For small businesses today, the most popular option is the Safe Harbor 401(k) plan, which generally satisfies the Internal Revenue Code’s non-discrimination rules for elective deferrals and employer-matching contributions. That means a Safe Harbor 401(k) eliminates certain testing requirements that potentially limit the amount of salary deferrals and matching contributions that highly compensated employees (HCEs) may receive under such plans.

A brand-new 401(k) plan must have at least three months remaining in the plan year to immediately start a Safe Harbor. Therefore, a calendar-year Safe Harbor 401(k) plan must be established by October 1, in order to receive an exemption from the Internal Revenue Code’s actual deferral percentage (ADP) test and the actual contribution percentage (ACP) tests. For a new company, however, there is an exception that allows it to establish a Safe Harbor plan with one month in the plan year. 

Design Flexibility
Fortunately, since 1999, plan sponsors can design their 401(k) to avoid ADP/ACP tests through meeting the requirements for a Safe Harbor plan. A Safe Harbor 401(k) plan is similar to a traditional 401(k) plan, but, among other things, it must provide for employer contributions that are 100% immediately and fully vested when made.

Plans that are designed to meet certain requirements are deemed to fall within the ADP and/or ACP Safe Harbors. As previously stated, these plans are exempt from ADP and, in some cases, ACP testing. Also, provided that there are no employer contributions other than ADP and/or ACP Safe Harbor contributions, the plan is also exempt from top-heavy requirements. 

Safe Harbor 401(k) plans also require timely participant disclosure requirements. Each eligible employee is given notice of his or her rights and obligations under the plan. The disclosure also serves as reminder of the advantages of plan participation and the steps to make or change salary deferral contribution amounts.

Reaching Safe Harbor
Electing to be treated as a Safe Harbor 401(k) plan has a number advantages for the business, but the plan also requires significant contributions on behalf of the employer. Employers who failed “testing” in previous plan years may be willing to take on higher costs in the form of fixed contributions to automatically get a pass on ADP/ACP tests. Why? Electing Safe Harbor status gives employers the added advantage of exemption from future ADP/ACP testing!

A Safe Harbor 401(k) plan, in exchange for fully and immediately vested employer contributions, permits HCEs to contribute the maximum salary deferral amount and receive an associated match exempt from the restrictions normally imposed by the ADP/ACP tests. Further, Safe Harbor plans that do not provide any additional contributions are also exempt from top-heavy testing. (In a top-heavy plan, the total account value of key employees generally exceeds 60% of the total account value of all employees in the plan.) Top-heavy 401(k) plans should almost always elect Safe Harbor status. Why? Top-heavy plans have a 3% minimum required contribution that can be satisfied by a Safe Harbor contribution.

An employer that wants to meet the Safe Harbor requirements and be exempt from testing must contribute either:

1. A match contribution of 100%, up to 3% of deferrals, plus a 50% match on the next 2% of deferrals of a matching formula that is equal to or greater than this formula; or

2. A qualified nonelective contribution of 3% of compensation.

In addition, an employer seeking Safe Harbor treatment must distribute annually a written notice before the beginning of the plan year to all eligible participants.

Safe Harbor Establishment Tips

  • A Safe Harbor feature may not be added to an existing 401(k) during the plan year.
  • In addition, by using the Safe Harbor rules, it’s also possible for an existing profit-sharing plan, without a 401(k) feature, to be amended to incorporate 401(k) and Safe Harbor features, as long as there are at least three months remaining in the plan year.
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