Safe Harbor 401(k) plans are designed to allow employers to automatically pass ADP/ACP and top- heavy nondiscrimination testing required by the IRS, as long as they provide a fixed mandatory contribution and meet other specific criteria which include notices. Safe harbor contributions are 100% immediately vested. A Qualified Automatic Contribution Agreement (QACA) is a Safe harbor plan that has an automatic enrollment feature.

When is Adding a Safe Harbor Beneficial?

More Contributions for Highly Compensated Employees (HCEs). Since a safe harbor 401(k) plan automatically passes the ADP/ACP test, HCEs can contribute up to the maximum allowed by law (or plan limits) without having to worry about the test failing and having refunds processed. Although refunds are not subject to early withdrawal penalties, they are taxable in the year distributed and reduce the overall retirement and tax benefit.

Top-Heavy Minimum. As long as the plan only has employee deferrals and safe harbor contributions (no other employer contributions), top-heavy minimum contribution requirements are automatically met. If the plan needs to make top-heavy contributions anyway, it makes sense to have a safe harbor plan.

Attract and retain employees. Safe harbor plans are very attractive because they provide a greater benefit by helping employees save for retirement. It offers a guaranteed employer contribution as well as accelerated vesting on the safe harbor contributions. When hiring employees that will become HCEs, it’s especially attractive if they want the ability to max out their contributions.

Simplified administration. If a plan fails ADP/ACP testing, the employer is either required to make a QNEC contribution or refunds need to be processed for HCEs within 2 ½ months following the close of the plan year. This doesn’t give the employer much time to get the data to their TPA and have the testing/refunds done. Failure to get corrections processed timely can result in costly consequences for the employer (such as an excise tax).

Tax Deduction. As with other employer contributions to a qualified retirement plan, safe harbor contributions are deductible to the employer.

 

Safe Harbor Requirements

Eligibility & Allocation Conditions

Less liberal eligibility requirements are permitted for safe harbor contributions. Employers can allow participants into the plan sooner for deferrals but can wait to make safe harbor contributions up to the maximum statutory eligibility period (up to one year of service and age 21).

Annual allocation requirements (such as being employed on the last day of the plan year or working a certain number of hours) are NOT allowed. Prolonging the eligibility for safe harbor contributions, however, is a way to restrict safe harbor eligibility. An employee, for example, may become eligible to make deferrals after 6 months of service but may never meet the eligibility requirement for the safe harbor if they don’t work enough hours.

Vesting

Classic safe harbor contributions are required to be 100% immediately vested. QACA safe harbor contributions, on the other hand, are not required to be 100% vested until a participant has at least 2 years of service. The employer can always be more generous with QACA vesting, though. For example, 50% after year one and 100% after year 2.

Additional Discretionary Employer Contributions

The employer can make additional contributions above the safe harbor amounts, but the following guidelines need to be considered in order to avoid additional testing:

1. Discretionary Match: Limited to a formula that does not match deferred compensation in excess of 6% or more than 4% of compensation. In addition, the match cannot have any allocation conditions or have a formula that increases as the deferral rate increases. Any match above these guidelines will require ACP testing.
2. Discretionary Nonelective (Profit Sharing): Plans that make additional profit sharing contributions are subject to top-heavy minimum requirements. An example of a potential issue is a top-heavy plan that is making a safe harbor match contributions that are only contributed to participants that make deferrals. If the plan is subject to top-heavy minimums, all eligible participants, regardless of whether they participant need to receive a top-heavy minimum, so additional top-heavy minimum contributions could be required.

Excluding HCEs

HCEs can be excluded from receiving safe harbor contributions if the document permits, which can help to reduce the overall cost of the plan to the employer.

Automatic Enrollment (under QACA)

Only QACA safe harbor plans are required to have an auto enrollment feature for participants that do not formally opt out. The minimum default deferral rate is 3% and the maximum is 15%. QACA plans are also required to automatically increase the deferral rate by at least 1% for automatically enrolled participant at least annually, until the participant reaches a 10% deferral rate.

NOTE: Secure 2.0 requires that all 401(k) plans established/signed on or after December 29, 2022 have an auto enrollment feature. Starting in 2025, the minimum default deferral rate is 3% with annual 1% escalations up to 10%.

Annual Notices

Notices are required 30-90 days prior to the start of the plan year (which must be at least 3 months for a new plan). For a QACA plan, the default election cannot be effective until the earlier of (1) the pay date for the second payroll period that begins after the date the notice is provided, and (2) the first pay date that occurs at least 30 days after the notice is provided.

Mid-Year Amendments

The IRS restricts the types of changes that can be made to a safe harbor plan mid-year. Some changes to a safe harbor plan are always prohibited mid-year, while other changes may be permitted if certain requirements are met. If a change is permitted, participants must be given notice 30-90 days before the effective date of the change.

 

Safe Harbor contributions need to be made for the full plan year in order to be exempt from ADP/ACP testing. If the plan is amended mid-year to suspend contributions, the plan will need to perform and pass nondiscrimination testing for the FULL plan year.

Examples of Impermissible Mid-Year Changes

The IRS references the following examples for impermissible changes:

1. Change the vesting on QACA contributions to a less favorable schedule (i.e. from 50/100 in years 1 and 2 to 25/100.
2. Reduce the number or group of employees eligible to receive safe harbor contributions. This

prohibition doesn’t apply to employees who aren’t already eligible (as of either the effective or adopted date of the change).

1. Change the type of safe harbor plan, for example, from a traditional safe harbor plan to a QACA

401(k) safe harbor plan.

1. Modify (or add) a formula for determining matching contributions (or the plan’s definition of compensation used to determine matching contributions) if the change increases the amount of matching contributions or permit discretionary matching contributions. However, a plan isn’t limited if the:

change is adopted at least 3 months before the end of the plan year, change is made retroactive for the entire plan year, and

the plan sponsor gives an updated safe harbor notice and election opportunities at least 3 months prior to the end of the plan year.

Classic Safe Harbor Contribution Formulas Safe Harbor Match

Once a participant meets the initial safe harbor contribution eligibility requirement, safe harbor matching contributions only need to be allocated to participants that contribute pre-tax and/or Roth deferrals to the plan. They do not need to be contributed to participants that are eligible but choose not to participate. This can be especially beneficial for a plan where not all participants are contributing.

Basic Match: The minimum safe harbor match is 100% on the first 3% of deferred compensation, plus a 50% match on the next 2% of deferred compensation. Under this formula, the maximum potential match is 4% of compensation.

Enhanced Match: This formula needs to be at least as generous as the basic safe harbor match at each tier of the match formula. A common formula, for example, is 100% match on the first 4% of deferred compensation.

 

Safe Harbor Nonelective

Safe Harbor Nonelective contributions, unlike safe harbor matching contributions, need to be provided to ALL participants that meet the initial safe harbor contribution eligibility requirement, regardless of whether they are making employee deferrals.

Nonelective: A minimum of 3% of the employees’ compensation needs to be contributed. The employer has the option to contribute more, though.

QACA Safe Harbor Contribution Formulas QACA Match

Just like the Basic and Enhanced safe harbor matching contributions, these are only contributed to participants that contribute pre-tax and/or Roth deferrals to the plan. The difference is that they can have less liberal vesting requirements, and the contribution formulas can be less costly.

QACA Basic Match: The minimum is 100% on the first 1% of deferred compensation, plus a 50% match on the next 5% of deferred compensation. The maximum potential match under this formula is 3.5% of compensation.

QACA Enhanced Match: This formula needs to be at least as generous as the QACA Basic Match at each tier of that formula. For example, the employer may choose a formula of 100% of the first 2% of deferred compensation, plus a 50% match on the next 5% of deferred compensation.

QACA Nonelective: Same minimum 3% of compensation formula as the Nonelective formula above.

Summary

Safe harbor 401(k) plans are a great option for plans of all sizes. The biggest disadvantage of a safe harbor plan is the cost of making employer contributions. However, the cost might be worth it if the employer is already making contributions to the plan and if it means that the HCEs, especially the owners, can contribute more to employee deferrals. It can also create peace of mind knowing that there is not a rush to get ADP/ACP testing done and that top-heavy requirements are met, if applicable.

Written by Tina Tufano, IPS Compliance Manager