What is a Safe Harbor 401(k) Plan?
Employee deferral and employer match contributions to a 401(k) plan must comply with non-discrimination rules. Annually, the average of the deferral rates of Highly Compensated Employees (HCEs) is compared with that of the Non-highly Compensated Employees (NHCEs) and, if the spread between the two averages is too great, corrective steps (often refunds to HCEs) are required. This comparison is referred to as the Actual Deferral Percentage (ADP) test. A similar test is performed on the employer match (as a rate of pay), referred to as the Actual Contribution Percentage (ACP) test.
However, there are “safe harbor” design options that, when incorporated into a 401(k) plan, effectively allow the plan to bypass the ADP test and, potentially, the ACP test. The main tenet of the safe harbor includes a commitment by the plan sponsor to make an employer contribution that vests at an accelerated rate.
Safe Harbor Options to Bypass the ADP and ACP Tests
- Safe Harbor Matching Contribution: NHCEs must be provided with a 100 percent match on the first 3 percent of compensation deferred, plus a 50 percent match on the next 2 percent of compensation deferred.
- Auto-enrollment Safe Harbor Matching Contribution: NHCEs must be provided with a 100 percent match on the first 1 percent of compensation deferred, plus a 50 percent match on the next 5 percent of compensation deferred (read this article to learn more about this safe harbor design option called, Qualified Automatic Contribution Arrangement (QACA).
- Safe Harbor Non-elective Contribution: Participating NHCEs must be provided with a contribution of at least 3 percent of their compensation, regardless of whether they deferred or not.
Each of these options may be supplemented by a discretionary, or fixed, matching contribution that either meets the safe harbor requirements for automatic passage of the ACP test, or is subject to ACP testing. Automatic passage of the ACP test is conditioned on the following requirements:
- deferrals in excess of 6 percent of compensation cannot be matched,
- the matching contribution may not exceed 4 percent of compensation (not applicable to a fixed matching contribution),
- the rate of match cannot increase as the rate of deferral increases, and
- there cannot be any requirements for participants to share in the matching allocation, such as a year-end employment requirement.
Safe Harbor 401(k) Implementation Deadlines for Plans Operating on the Calendar Year
401(k) plans providing for a safe harbor component must be implemented no later than October 1st to be effective for the same plan year. This deadline would apply to any current profit sharing (only) plan that adds a 401(k) and safe harbor feature, as well as to any newly implemented 401(k) plan that will include for a safe harbor provision.
The October 1 deadline applies to employers who:
- Who wish to implement a new safe harbor 401(k) plan in the same calendar year,
- Add a new safe harbor 401(k) plan to an existing profit-sharing plan in the same calendar year,
NOTE: The salary deferral provision in a new 401(k) plan must be effective for at least three months to take advantage of the safe harbor design.
The December 1 deadline applies to employers who:
- Have an existing 401(k) plan and wish to add a 3% safe harbor non-elective feature for the current calendar year. NOTE: This extended deadline option is not available for new plans or existing 401(k) plans that wish to utilize a safe harbor match.
- Have an existing safe harbor 401(k) plan and wish to modify their safe harbor type (i.e., match or non-elective) for the following year.
NOTE: For employers who miss the December 1 deadline to add the 3% safe harbor contribution feature to their existing 401(k) plan for the current calendar year, the SECURE Act of 2019 offers a new option. Employers have an additional 13 months (to December 31 of the following year) to adopt an amendment adding a 4% safe harbor contribution feature for the current year. The increase to 4% is required for the initial year only; in later years 3% may be provided. This retroactive adoption option is not available for a safe harbor match.