A Safe Harbor 401(k) plan allows employers to avoid most annual compliance tests, but in exchange for this benefit, they must make annual contributions on behalf of employees. Those contributions are vested immediately. Two of the three types of Safe Harbor contributions involve matched funds, hence the term Safe Harbor match.

Types of Safe Harbor Matching Contributions

Matching contributions made by an employer match a certain percentage of the employee’s contribution. Safe Harbor plans use two types of matching formulas:

  1. Basic Matching: The employer matches 100% of each employee’s 401(k) contributions, up to 3% of their yearly compensation, plus a 50% match of the next 2% of their contributions.
  2. Enhanced Matching: At minimum, the employer contributes 100% of each employee’s 401(k) contributions, up to 4% of their compensation.

Alternative matching formulas may be available, depending on the specifics of your plan.

Do You Need a Safe Harbor Provision?

Nondiscrimination testing was designed with big businesses in mind. The IRS wants to make sure retirement plans are not created for the sole benefit of Highly Compensated Employees. Yet, if a small business only has a handful of employees, the business owner’s own contributions can cause the benefits to appear lopsided and cause the company to fail the annual test. This is an expensive and time-consuming bureaucratic headache.

Safe Harbor provisions are ideal for small businesses who want to maximize their retirement contributions and tax savings, while also offering 401(k) benefits to their employees. It’s never too early or too late to consider a Safe Harbor small business 401(k).

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Alternatives to Safe Harbor Employee Match

An employer can opt out of matching contributions, choosing nonelective contributions instead. Unlike matching contributions, nonelective contributions are given to ALL eligible employees, even if they are not making salary contributions to the plan. Under this provision, employers contribute 3% (or more) to all plans equally. The IRS allows total employer/employee contributions to reach a maximum of $66,000 for those under 50 and $73,500 for those age 50 and older.

Match or Nonelective Contribution?

Choosing a Safe Harbor match or nonelective contribution depends on a company’s goals. For instance, a company might opt for the nonelective contribution to ensure that ALL employees benefit from the offered retirement benefits, which can be great for employee retention, morale, and productivity.

On the other hand, a match may be a better option for companies trying to encourage participants to save for themselves.

Which option is more cost-effective will depend upon employee participation. The minimum nonelective contribution is 3% and applies to all employees regardless of their contributions. If the employer match option is selected and not that many employees defer or defer at lower rates, the matching contribution will be the less expensive option. However, if most participants strive to hit the maximum match, the nonelective contribution will cost less.

Changing a Plan to Safe Harbor

Employers looking to start a new plan may contact Ubiquity to set up a plan for 2023. Making the change from a traditional 401(k) to a Safe Harbor requires a formal plan amendment. Employers who would like to add a Safe Harbor provision to prevent ACP/ADP failure this past year should have the changes made by September 1. Contact Ubiquity to learn more about Safe Harbor 401(k) options for your small business.