What is a “safe harbor” plan design, and what does it do for companies and their employees?

When dealing with a 401(k) plan, the plan sponsor may elect to contribute the safe harbor minimum contribution, which avoids the actual deferral percentage (ADP testing) of the employee’s deferral contribution. It also avoids the actual contribution percentage (ACP testing) of employee matching contributions.

“Safe harbor contributions may be a good choice for companies that offer to match employee contribution already or that fail ACP and ADP testing.”

ADP and ACP testing can lead to refunds and tax headaches for company owners and other highly compensated employees. There are three safe harbor contribution formulas that you can use to avoid these tests:

  1. Safe harbor non-elective contribution. The employer would make a non-elective contribution equal to at least 3% of an employee’s compensation. 
     
  2. Safe harbor basic matching contribution. In this case, the employer would match 100% of an employee’s deferral, up to 3% of their compensation, and 50% of deferral for the next 2% of compensation. Essentially, for employees deferring 5% of their pay, the employer would make a 4% employer contribution.
     
  3. Enhanced matching contribution. Here, the employer makes a different rate of contribution to satisfy safe harbor, and there are a few conditions that must be met. It has to be a fixed formula, and the rate of any matching contribution in the plan can’t increase as the employee’s rate of elective deferral increases. The safe harbor matching amount for each employee is at least equal to the amount that would have gone to the regular safe harbor formula we just described. For example, there would be a 100% match on the first 4%.

Safe harbor contributions may be a good choice for companies that offer to match employee contribution already or that fail ACP and ADP testing. It may increase your overall benefit cost, but you’ll have a more successful plan. If you’d like to see how these plan designs can help you and your employees, feel free to reach out to me at 781-876-4113. I look forward to hearing from you soon.