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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 make sure that a 401(k) does not discriminate in favor of highly compensated employees, including owner-employees. Failing such a test may limit the amount 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 percent of the small firms responding to the survey use a safe harbor 401(k) plan design to avoid annual non-discrimination 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.

Employer options

Employers have several ways to reach this safe harbor. Many companies prefer the ‘basic match’ approach. Here, the company matches 100 percent of employee contributions to the 401(k), up to three percent of compensation, plus a 50 percent match on contributions up to five percent of pay. Thus, the maximum match is four percent of an employee’s compensation. (Some companies use an ‘enhanced match,’ which might be 100 percent on the first four percent of pay).

Alternatively, employers can shelter in a safe harbor with a ‘non-elective contribution.’ Here, the company contributes three percent 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.

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