Safe Harbor 401(k) Plans for Small Companies
Among employer-sponsored retirement plans, 401(k)s have become the standard. Some prospective employees assume that a job will come with a 401(k). Therefore, offering a 401(k) at your company may help you hire desired workers, and help you retain valued employees.
That said, there can be drawbacks to sponsoring a traditional 401(k). Such plans require annual testing to ensure that a 401(k) does not discriminate in favor of highly compensated employees, including owner-employees. Failing such a test may limit the amount that company principals and certain others may contribute to the plan, resulting in a reduced tax-deferred retirement fund for key individuals.
One solution is to offer a safe harbor 401(k) for your small business. A study released in late 2016 by Employee Fiduciary, a 401(k) provider for small businesses, found that 68% of the small firms responding to the survey use a safe harbor 401(k) plan design to avoid annual nondiscrimination testing. A safe harbor 401(k) allows sponsoring companies to avoid these tests, providing the business makes certain contributions to employees’ accounts. The mandatory employer contributions are always 100% vested.
Employers have several ways to reach this safe harbor. Many companies prefer the “basic match” approach. Here, the company matches 100% of employee contributions to the 401(k), up to 3% of compensation, plus a 50% match on contributions up to 5% of pay. Thus, the maximum match is 4% of an employee's compensation. (Some companies use an “enhanced match,” which might be 100% on the first 4% of pay.)
Alternatively, employers can shelter in a safe harbor with a “nonelective contribution.” Here, the company contributes 3% of compensation to each eligible employee’s 401(k) account, regardless of whether a worker is making elective deferrals.
Either way, the safe harbor contributions can be limited to employees earning less than $120,000 in 2017.
Considering the costs
Safe-harbor 401(k)s might not be a good fit for every small business. The required employer contributions may wind up being extremely expensive. Other efforts, such as employee education that increases contributions from non-highly compensated workers, may be a more cost-effective approach. Also, safe harbor 401(k)s have certain notice requirements. If you are interested in a safe harbor 401(k) for your company, our office can explain the notice requirements and provide an estimate of the cost involved, to help you make an informed decision.