A good retirement plan is a huge incentive for employers to offer these days. Individuals who are weighing their options between two companies, will often elect to go with the company that offers excellent retirement benefits.
However, when selecting a 401k plan as an employer, you need to be aware that there are annual IRS compliance testing considerations that may impact you. These tests are given to businesses by the IRS each year to ensure fairness in their 401k plans. In the following article we will outline the basics of the Safe Harbor 401k plan so that you can determine if it is a good option for your business.
What is a Safe Harbor 401k Plan?
Safe Harbor 401k plans are retirement plans that enable businesses to get the most out of their 401k plan while ensuring fairness for all eligible members of the company. The tests that are automatically bypassed through the implementation of a Safe Harbor plan are as follows:
- The ADP Test (Actual Deferral Percentage): For small businesses, this is likely to be the most applicable test. This IRS test ensures that there is a cap on the percentage of compensation that higher earners within your company can contribute to their retirement plan each year. This amount is compared to the average contributions from lower-wage employees within your company.
- The ACP Test (Actual Contribution Percentage): This test is imposed on businesses to confirm that employer matching amounts for higher-paid workers are proportional to lower-wage workers within the company.
- The Top-Heavy Test: With the goal of fairness within your company’s retirement plan in mind, this test ensures that the higher earners within your company hold less than 60% of the total balance within the 401k plan.
Failing these tests results in a nightmare for business owners. Potential penalties, corrective payments, and heaps of paperwork await you if you should fail any or all of these tests. Therefore, it’s best to ensure that you will pass these compliance tests each year.
How Does a Safe Harbor 401k Help My Business Pass the IRS Compliance Tests?
Safe harbor plans are designed specifically for your business to pass the IRS testing requirements. You essentially have 3 options for contributing to your employees plans in a Safe Harbor 401k plan:
- Basic Matching. Employee 401k contributions are matched 100% by employer, at 3% or less of employee compensation, and 50% match of following 2% of employee deferrals.
- Enhanced Matching. Company matches 100% or more of employee contributions at 4% or less of employee compensation.
- Non-elective Contribution. Without regard to contributions by employees, the employer matches 3% or more of their compensations.
Can I Still Set Up a Safe Harbor 401k Plan This Year?
If you are considering creating a 401k plan with a safe harbor provision, the plan must begin by October 1st, 2021. On the other hand, if you simply want to add a safe harbor plan to your already existing 401k plan, the deadline to request the provision is November 30th, 2021.
