In the United States, the most common type of retirement plan is the trusty 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 can be a particular win-win. Safe harbor plans can maximize a company’s tax savings and retain employees, all while simplifying responsibilities for the employer.
So what exactly is a safe harbor 401(k), and what makes it so special? For this article, Patriot and Vestwell have partnered to help you understand this unique type of plan available to you now.
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 Generally, contributions to this account are automatically withdrawn from an employee’s paycheck and invested into funds of the employee’s choosing.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 and contributions become fully vested when made. Contributions can either be limited to employees who make deferrals or offered to all eligible employees.
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 otherwise have difficulty passing compliance tests.
There are three “categories” of employer contributions that a business can choose to commit to when designing its safe harbor plan. These include:
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 best 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.
Thanks to the 2019 SECURE Act, small businesses can receive a tax credit as high as $16,500 for starting a new, qualified retirement program—which includes a safe harbor 401(k).
The tax credit is equal to $250 for each non-highly compensated employee (NHCE) who is eligible to participate in the plan, with a minimum credit of $500 and a maximum credit of $5,000, for three years. Additionally, if a business adds an auto-enrollment feature to your plan, known as an eligible automatic enrollment arrangement (EACA), they can claim a tax credit of $500 per year for a three-year taxable period. However, they must notify employees of the auto-enrollment feature and withhold wages from automatically enrolled participants at the plan’s default deferral rate.
Safe harbor plans are available to everyone at a company, including business owners who work for their company. These employers can contribute the maximum annual deferral amount to their own 401(k) plan, which is $20,500 for 2022 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.
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.
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 there are some important dates to know:
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.
Patriot and Vestwell have partnered to offer affordable retirement plans for small businesses across the United States. Vestwell’s digital retirement platform directly integrates with Patriot’s payroll software, making 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, Vestwell has created custom programs for Patriot customers that are incredibly affordable, and easy to set up and use.
Interested? Start your safe harbor search here.