As Oct. 1 rolls around, it is time for business owners to make an important decision about the type of 401(k) plan they are going to offer employees. It is the annual deadline for setting up a Safe Harbor 401(k), a type of retirement plan that makes it possible for business owners to maximize their contributions to their accounts without running afoul of the IRS' nondiscrimination testing requirements for traditional 401(k) offerings.
Retirement plan experts say Safe Harbor 401(k) programs offer a practical and efficient way for small employers to provide retirement benefits to their employees, including themselves. Using this type of 401(k) plan, business owners can max out their contribution ($16,500 per employee or $22,000 for employees over the age of 50) and receive additional savings through the match.
"The Safe Harbor 401(k) does remove some of the perceived risk of compliance testing for small-business owners," said Janice Nearen-Bell, vice president of human resource services sales at Paychex, a Rochester, N.Y.-based provider of payroll, human resources and benefits outsourcing solutions for small and mid-size businesses.
While any size of company can offer a Safe Harbor 401(k), it is geared toward small- business owners. Safe Harbor plans can be structured in two ways. One option is a dollar-for-dollar matching contributions for all participating employees on the first 3 percent of each employee’s compensation and a 50 percent match from 3 percent to 5 percent. The plan can also be structured to provide 3 percent to each eligible employee’s compensation, regardless of whether they participate in the plan. These plans could be expensive for larger businesses, which would likely have more participants.
The tradeoff for the small-business owner is more flexible guidelines than a traditional 401(k) plan. In traditional 401(k) plans, there are specific tests that are typically administered. These tests are designed to enforce the requirements that keep owners from intentionally or unintentionally driving most of the benefit of these plans to themselves at the cost of their employees.
"In exchange for foregoing the tests required of a traditional 401(k), the plan sponsors must give money to their rank-and-file plan participants," said Robert Gordon, senior financial adviser for Coconut Grove, Fla.-based Investor Solutions. "If the company is close to not being able to meet the testing requirements for a traditional 401(k) — and a qualified adviser can help determine that — it is most likely in their best interest to choose a Safe Harbor 401(k)."
Going with a Safe Harbor plan from the beginning can help business owners avoid additional fees. “The reason for going Safe Harbor from day 1 is the belief that employees will defer a lot less than owners of the company, so they will fail the deferral discrimination test, or matching discrimination test or top heavy (where 60 percent of the assets reside with key employees),” said Ary Rosenbaum, an ERISA/ retirement plan attorney for his firm, Garden City, N.Y.-based The Rosenbaum Law Firm P.C. "Failing discrimination tests requires correction, either refunds or required contributions,” So a Safe Harbor contribution gets a free pass on discrimination testing."
"The flexibility of the Safe Harbor 401(k) helps the small-business owner, and many employers can set up a 401(k) plan for a low monthly cost, depending on the size and complexity of the plan," Paychex’s Nearen-Bell said.
She also noted that employers can receive a tax credit of up to $500 per year for each of the first three years in which they implement a plan. The Safe Harbor option also offers roll-over and portability. As of 2010, the federal government allows a plan to include a feature that lets 401(k) plan participants to roll over and convert pre-tax dollars into a Roth 401(k).
Organizations that want to establish a new Safe Harbor plan must use one of the following employer methods of contributing to the plan — either by matching participant deferrals (qualified matching formula) or by making a contribution not dependent on an employee deferral (nonelective formula).
"Under a qualified matching formula, the plan sponsor is required to match at least 100 percent of the first 3 percent deferred by a participant and 50 percent of the next 2 percent," said Todd Cowman, consultant, retirement investor services for the Principal Financial Group, a Des Moines, Iowa-based financial services firm. "Under a qualified nonelective formula, the employer is required to provide a non-matching contribution of at least 3 percent of pay to all eligible non-highly compensated participants. Both contributions are required to be fully vested when contributed to the plan."
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