Last Updated: July 21, 2023

In the United States, the most common type of retirement plan is the 401(k). With over 60 million active participants and an estimated $7.3 trillion in assets, businesses of all sizes offer this type of plan to help their employees save for the retirement they deserve.

However, not all 401(k)s are the same. While offering any retirement plan can be a huge benefit, a “safe harbor” 401(k) plan may be particularly advantageous. Safe harbor plans can maximize a company’s tax savings and help retain employees, all while simplifying responsibilities for the employer.

So what exactly is a safe harbor 401(k), and what makes it so special?

Safe Harbor 401(k) Plans - The Basics

What is a Safe Harbor 401(k)?

Like a traditional 401(k), a safe harbor plan gives employees access to a tax-advantaged savings and investment account. Generally, contributions to this account are automatically withdrawn from an employee’s paycheck and invested into funds of the employee’s choosing.

However, the key difference between a traditional and a safe harbor 401(k) is in the employer contribution: With a safe harbor plan, the employer is required to make contributions to their employees’ accounts. With many types of safe harbor 401(k)s, these required contributions must be immediately 100% vested. There are exceptions - for example, with QACA 401(k) plans, the vesting schedule could be up to 2 years.

How Do Small Businesses Benefit From Safe Harbor Plans?

When 401(k) plans were first introduced, a central goal of the program was to ensure as many employees as possible participated and that businesses didn’t disproportionately favor their highly-compensated employees when making employer contributions.

As a result, traditional 401(k) plans are subject to what’s called “non-discrimination testing,” a form of compliance auditing that ensures the average contributions of highly paid employees does not exceed those of everyone else by more than 2%.

If the thought of this added paperwork turns you off, then a safe harbor plan may be for you.

Unlike traditional 401(k) plans, safe harbor plans automatically pass a number of required tests that keep the plan tax-qualified and avoid other penalties and costs. For this reason, safe harbor plans can be a great choice for small businesses that could have trouble passing nondiscrimination testing. For example, a family-owned or small business with more highly compensated employees relative to "rank and file" or non-highly compensated employees may benefit from a safe harbor plan.

How Do Employer Contributions Work in a Safe Harbor Plan?

There are three main “categories” of employer contributions that a business can choose when designing its safe harbor plan. These include:

• Basic match: The employer matches 100% on the first 3% of deferred compensation, plus a 50% match on the next 2% of deferred compensation.
• Enhanced match: The employer provides a match that is at least equal to what would have been made under a basic plan. A common formula is 100% match on the first 4% of deferred compensation.
• Non-elective: Company contributes 3% or more of each employee’s compensation, regardless of whether the employee also makes elective deferrals.

The best contribution formula for each company will depend on the goals they have for their retirement plan. For example, if your primary goal is ensuring everyone receives a contribution no matter what, then a non-elective formula may be well suited for your business. On the other hand, if you like the structure of a traditional 401(k) but want to avoid the compliance testing, then an enhanced match formula may be better.

More Good News About Safe Harbor Plans

SECURE Act Tax Credits

Thanks to legislation dubbed "SECURE 2.0," small businesses can receive significant tax credits for starting a new, qualified retirement program—which includes a safe harbor 401(k).

Employers with 50 or fewer employees can receive a startup credit of 100% of administrative expenses, up to $5,000 per year, for three years. The full credit is available to employers with 50 or fewer employees, phasing out for employers with more than 100 employees. Additionally, employers can also receive a tax credit equal to the amount of contributions they have made on behalf of non-highly compensated employees, up to $1,000 per employee.

Taken together, the changes brought by SECURE 2.0 have made it significantly more affordable for small businesses to start a new retirement plan like a safe harbor 401(k).

Benefits for Business Owners

Safe harbor plans are available to everyone at a company, including business owners who work for their company. With a safe harbor plan, employers can contribute the maximum annual deferral amount to their own 401(k) plan, which is $22,500 for 2023, plus any catch up contributions.

Further, come tax time, employers will be able to minimize their business’s expenses by deducting applicable employee and employer matching contributions from the company. Because many owners pay themselves out of their company’s profits, these savings can directly improve their bottom line.

There is Still Time to Maximize the Savings Before the New Year

Safe harbor plans must be in effect three months prior to the plan year-end date, which means eligible employees must be able to make salary deferrals starting no later than the first pay date on or following October 1.

Businesses interested in offering a safe harbor 401(k) plan should gear up to act soon: Leave time to get your plan up and running so you can give employees long enough to make elections before their first payroll.

Dates to Know for Switching to a Safe Harbor Plan

If you already have a different type of plan, no worries at all. You can always amend your offering to take advantage of safe harbor benefits, but here's a deadline to keep in mind:

• August 24, 2023: Start a new Safe Harbor plan with Vestwell.

Overall, there are benefits to any type of retirement offering, but a safe harbor plan can be a smart decision for many companies, particularly small business owners.

Start your Safe Harbor 401(k) Plan

Running a small business is hard, but running your 401(k) shouldn't be. If you’re interested in opening up a safe harbor retirement plan, Vestwell can help.

Vestwell is a digital retirement plan platform that makes it easier for you to offer and administer a company-sponsored 401(k) or 403(b). By combining technology with best-in-class retirement plans and user-first design, Vestwell offers a wide range of services to small businesses everywhere.

If you are an employer interested in setting up a 401(k) account for your business, you can contact Vestwell to determine if you are eligible to receive generous tax credits from SECURE 2.0, which can cover up to 100% of your retirement plan costs for the first three years of service. Interested? Start your safe harbor search here.