Safe Harbor 401k
Safe Harbor 401(k) plans are like traditional 401(k) plans, but they offer advantages to businesses at risk of failing the non-discrimination tests. Small business owners and highly compensated employees (HCEs) are impacted when they want to make significant contributions to the 401k and the non-highly compensated employees (NHCEs) do not.
Highly compensated employees are generally defined as individuals with more than 5% ownership, family members of a more than 5% owner (spouse, parents, children or grandparents) or employees earning more than $115,000 in the previous calendar year. A Safe Harbor 401k can be beneficial for small business owners who want to max out the salary deferral contributions (2015 limits $18,000 and $24,000 if age 50+), but anticipate their small business 401k plan will have problems with non-discrimination testing. The Safe Harbor 401k plan allows owners and highly compensated employees to make the maximum salary deferral contributions to a 401k even if the other employees want to make limited or no contributions to the 401k.
With a Safe Harbor 401k, the business must make contributions to the business owner, to highly compensated employees and to non-highly compensated employees according to one of the following 3 formulas:
- Basic - Match 100% of the first 3% of compensation, plus 50% of the next 2% of compensation.
- Enhanced - Match 100% on the first 4% of compensation.
- Non-Elective - Contribute 3% of compensation to all eligible employees.
Each year the employer must make either the matching contributions or the non-elective contributions. The plan document will specify which contributions will be made and this information must be provided to employees before the beginning of each year.
What are the advantages of a Safe Harbor 401k to small businesses and small business owners?
With a Safe Harbor 401k the small business owner can contribute the maximum 2015 annual deferral amount $18,000 ($24,000 if age 50+) to a 401k plan regardless of the whether or not the employees contribute to the 401k. Safe Harbor contributions are made by the employer to the employees and to the small business owner. Safe Harbor 401k plans make it easy for business owners to maximize contributions to their own accounts while reducing some of the limitations with complying with the IRS non-discrimination testing rules.
IRS 401(k) rules ensure that 401k plans do not favor Highly Compensated Employees (HCEs) over Non-Highly Compensated Employees (NHCEs). The government has established required compliance tests (ADP, ACP and Top Heavy) to verify all employees have fair representation in a 401k plan. The Safe Harbor 401k plan helps a small business automatically pass the non-discrimination testing by making contributions on behalf of the small business owner and to employees.
What are the non-discrimination tests in a 401(k) plan?
There are three main types of compliance tests required to be performed on a 401(k) plan annually. This compliance testing is required by IRS rules to ensure a small business owner does not have a 401k plan that treats employees unfairly.
- Actual Deferral Percentage (ADP) test compares the deferral percentage of HCEs and NHCEs. Generally, the HCE deferral amount cannot be more than two percentage points higher than the average for the NHCEs.
- Actual Contribution Percentage (ACP) test compares employer matching contributions between the HCEs and NHCEs.
- Top Heavy test determines if the account balances of key employees is greater than 60% of the total assets of the plan.
Safe Harbor 401k plans are deemed to satisfy these non-discrimination tests, so business owners and other highly compensated employees may defer the maximum salary deferral contribution regardless of low participation from non-highly compensated employees.
What are the disadvantages of a Safe Harbor 401k to the small business owner?
The small business owner is required to make the Safe Harbor contribution to themselves and to any other HCEs and NHCEs. As a result Safe Harbor 401k plans work particularly well for companies that have consistent revenue and cash flow. Businesses finding it difficult to maintain the required employer contribution year round may find that a traditional 401k plan without a Safe Harbor feature may make more sense.
What is the advantage of a Safe Harbor 401k versus a traditional 401k plan for a small business owner?
A Safe Harbor plan avoids IRS testing. To avoid non-discrimination testing a small business owner contributes to their employees’ 401k account and to the business owner’s 401k account.
How is a small business owner and the highly compensated employees impacted in a traditional 401k?
All HCEs will be limited to defer only 2% more than the average of all eligible Non-Highly Compensated Employees (NHCEs). Example if the NHCEs contribute an average of 2% of their salary to a traditional 401k than the HCEs can only contribute 4% of their salary to the 401k plan. If NHCEs elect to put in 0% in the 401k plan then with a traditional 401k HCEs would not be able to contribute to a traditional 401k.
Are Safe Harbor 401k contributions made to the employees and to the small business owner a tax deductible business expense?
Yes, contributions made to a Safe Harbor 401k are generally 100% tax deductible as a business expense.
What is the deadline to setup a Safe Harbor 401k?
Safe Harbor 401k plans are required to be set up 3 months prior to the plan year end. For businesses with a December 31 tax year end then the deadline to setup a Safe Harbor 401k is October 1st.
Profit Sharing Plan
Are there any other 401k options that may be beneficial for a small business owner who would like to maximize contributions to the 401(k) plan?
A small business owner may want to add a profit sharing plan to the Safe Harbor 401k if they want to maximize their contributions to a retirement plan. Profit sharing plans are 100% funded by the employer and are generally 100% tax deductible. 401k plans can have custom features and BCM helps small businesses with their 401k plan design to maximize the benefits to our small business clients while maintaining compliance with the IRS rules. One example of this would be to potentially add a New Comparability Profit Sharing Plan to the 401(k) plan.
New Comparability - Profit Sharing Plan
A small business owner may want to add a profit sharing plan to their 401k. One type of profit sharing plan is a New Comparability Plan. If a small business owner would like to maximize the profit sharing contribution to the business owners or key employees while minimizing the contributions into the other employees they may be interested in establishing a New Comparability Plan. A New Comparability Plan is a profit sharing plan in which employees are divided into groups with each group receiving an employer contribution that is a different percentage of compensation. A small business can set up a New Comparability Plan to maximize contributions to the business owner and to benefit key employees while still satisfying IRS rules for a 401k profit sharing plan.
Small Business 401k Services
One of the important services we provide is to serve as objective 401k plan specialists to educate HR directors, CFO's and business owners regarding the available 401k plans for small businesses in the market place.
Small Business 401k Plan Provider Search
Once we have helped educate you regarding the possible 401k plan options for your firm and we know the criteria that is important to you, we begin our search to help you find a 401k provider best suited for your specific situation. Beacon Capital Management Advisors works with many small business 401k plan providers and our search to find your ideal plan is efficient, cost effective and hassle free.
Receiving a Small Business 401k Plan Proposal
Whether your company is starting a new 401k or you have an existing plan and are looking for better administration, more investment choices, lower costs or better employee education, BCM can assist you in this process. Complete the form below to receive a small business 401k proposal.