Understanding the differences between safe harbor and traditional defined contribution (DC) retirement plans will help employers decide which they should sponsor.
The primary difference between safe harbor and traditional plan designs is that safe harbor plans give the ability to forego nondiscrimination testing for Employee Retirement Income Security Act (ERISA) 401(k) and 403(b) plans, says Joe Buhrmann, senior financial planning consultant at eMoney Advisor. Plan sponsors do not have to perform actual deferral percentage (ADP) and actual contribution percentage (ACP) testing if certain rules are followed regarding employer contributions.
With a safe harbor plan, the rules for employer contributions require plan sponsors to make a traditional match that equals 4% of employee deferrals—for example, 100% of employee deferrals up to 3% of compensation plus 50% of employee deferrals between 3% and 5% of compensation—or a qualified non-elective contribution (QNEC) of 3% for all eligible participants, even if they are not deferring. Plan sponsors can also offer a mix of the two.
According to the IRS, matching contributions made to a safe harbor plan that is not a qualified automatic contribution arrangement (QACA) must be 100% vested at all times to satisfy the ADP test safe harbor. Matching contributions to a QACA safe harbor plan must be 100% vested after a participant completes no more than two years of service to satisfy the ADP test safe harbor. Additional contributions can be subject to any permissible vesting schedule.
Michael Ingram, a partner and wealth adviser at Octavia Wealth Advisors, says plan sponsors should only consider a safe harbor plan if they have issues with passing nondiscrimination testing and want to help highly compensated employees (HCEs) maximize their retirement plan contributions.
“If they fail testing, highly compensated employees will have to get a refund and lose their tax deduction or employers will have to make a nonelective contribution anyway,” he explains. “It could cost [plan sponsors] more money than if they chose the safe harbor plan to begin with.”
Another distinction between safe harbor plans and traditional DC plans is that safe harbor plans that do not provide any additional contributions in a year are exempted from the top-heavy rules, Ingram says. A plan is considered top heavy—and would require employer contributions to non-key employees—if key employees (owners, certain shareholders and company officers) hold more than 60% of the plan’s assets in their accounts, he adds.
Ingram says managing a safe harbor plan might be easier since there is no testing and could save plan sponsors money. “It can save your staff time and possibly lower your fees,” he notes. “Most providers charge less for safe harbor plans because there is less administration involved.”
For employers that want to switch an existing, traditional 401(k) or 403(b) plan into a safe harbor plan, the Setting Every Community Up for Retirement Enhancement (SECURE) Act allows plan sponsors to do so at any time during the year, as long as it is done within 30 days before the close of the plan year, and with a 3% or greater contribution provided retroactively for the full year, according to Ingram.
The SECURE Act also allows plan sponsors to adopt a safe harbor plan up until the last day prior to the beginning of the plan year, but a 4% or greater contribution must be provided retroactively for the full plan year, he says.
According to the IRS, sponsors of safe harbor plans must satisfy certain notice requirements. The notice requirements are satisfied if each eligible employee for the plan year is given written notice of their rights and obligations under the plan and the notice satisfies the content and timing requirements.
In order to satisfy the content requirement, the notice must describe the safe harbor method in use, how eligible employees make elections and any other plans involved. The timing requirement is that the employer must provide notice within a reasonable period before each plan year. This requirement is deemed to be satisfied if the notice is provided to each eligible employee at least 30 days and not more than 90 days before the beginning of each plan year. There are special rules for employees who become eligible after the 90th day.
Section 103 of the SECURE Act removed the requirement to provide an annual safe harbor notice for nonelective safe harbor 401(k) plans—i.e., those with only nonelective employer contributions.
Buhrmann emphasizes that it’s important for plan sponsors to work with an adviser, a consultant or ERISA counsel to determine which type of retirement plan is most appropriate for their situation. He notes that this is especially true for smaller employers.
“Often, key employees of smaller businesses with traditional plans are unable to fully maximize contributions,” he says. “Considering a safe harbor plan, even though the organization may be required to make matching or non-discriminatory contributions, might allow them to do so.”