Adopting a Safe Harbor 401(k) Plan
By Mike Rahn, CISP
When our small business clients talk with us about starting a retirement plan, some have mentioned a “safe harbor” 401(k). Is that different from other 401(k) plans?
A safe harbor 401(k) plan design is one in which a relatively modest employer contribution commitment can open the door for any employee to maximize their own salary deferrals into the plan. The primary benefit of the safe harbor model is the assurance that salary deferrals contributed by owners and other highly paid employees will not be restricted by low participation among employees who are statutorily classified as “non-highly compensated employees.”
The required employer contribution in a safe harbor plan may be in the form of a match on eligible employees’ salary deferrals, given only to those who contribute. Or, it may be in the form of a nonelective contribution made to all eligible employees. In a safe harbor 401(k) plan, certain other plan testing benefits may also apply.
Is this a favorable time to set up this kind of plan, considering how late in the year it is?
There is really no bad time to set up a 401(k) plan. But in order to provide benefits to more than just the highly paid employees, employers may only establish a new safe harbor 401(k) when there are at least three full months remaining in the plan year. This would be October 1 for a calendar year plan, which most safe harbor 401(k) plans are. A fiscal year plan could possibly have a later deadline.
What is considered “established?” There is not a great deal of time before October 1 for a calendar-year safe harbor 401(k) plan. Does signing plan documents satisfy this requirement?
Signing documents is not sufficient. Time constraints would favor a smaller employer, one for whom communication with employees can be direct and immediate. The most time-sensitive task will be collecting salary deferral elections in time to have deferrals withheld from compensation earned as of October 1 and thereafter. Again, a fiscal year plan might have more leeway.
Is this true for all business structures? We thought that one of the SECURE 2.0 provisions allowed sole proprietors both to establish a 401(k) plan and fully fund it as late as their tax return deadline. This seems to conflict with the October 1 timeline you describe.
These are two separate issues. It’s true that a 401(k) plan can generally be established as late as a business’s tax return deadline. Employer contributions—such as profit sharing—can always be made at that time. If the business owner is a sole proprietor, the owner's salary deferrals may also be contributed at that time, but only in the plan’s first year, and only if there are no common law employees. Perhaps more important, a sole proprietor that has no common law employees would have no need for a safe harbor plan design, because the absence of non-highly compensated employees means there would be no contribution testing limitations.
If a business already has a 401(k) plan, can it be amended to have a safe harbor design? If so, when must this happen?
If a business already has a 401(k) plan, it can be amended to a safe harbor design, but the type of employer contribution and amendment timing are linked. If an employer wants to qualify for the actual deferral percentage test (ADP) safe harbor using matching contributions—given only to those employees who defer—notice must be given to employees no less than 30 days and no more than 90 days before the start of the next plan year.
If the employer will instead make nonelective contributions to all eligible employees—regardless of whether they elect to make salary deferrals—amending can be done at any time during the current or coming plan year, without prior notice. If the amending takes place during the first 11 months of the plan year, the employer nonelective contribution must be at least three percent of each eligible employee’s compensation. If amended during the last month of a plan year, or during the following plan year, the employer nonelective contribution must be at least four percent.
