Pinnacle Plan Design designs and administers 401(k) and profit sharing plans for firms across the nation. Many employers are looking to maximize their annual contributions to their retirement plan, but run into issues with non-discrimination testing. Safe harbor 401(k) plans are a great way to bypass certain non-discrimination tests and they enable owners to defer the maximum amount into the 401(k) plan.

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 Average Deferral Percentage (ADP) test.  A similar test is performed on the employer match (as a rate of pay), referred to as the Average 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

1. 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.
2. 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.
3. 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.

For questions about safe harbor 401(k) please, please contact us.