Primer Article: Selecting the right safe harbor provision for your plan is easy if you know your company, your people, and a few of the basics.
Last Updated: August 4, 2020
What Is This "Safe Harbor" Term Anyway?
As if it weren't confusing enough, the term “safe harbor” is used throughout the IRC (Internal Revenue Code) to describe conditions that eliminate or reduce a taxpayer’s liability under the law. With regard to retirement plans, meeting “safe harbor” requirements frequently grants nondiscriminatory status to a particular plan provision, thus eliminating the need for additional testing.
Here we are going to explain what "Safe Harbor" means under IRC §401(k)(12). These are the Safe Harbors you most likely have discussed with us or your financial advisor. For a deeper dive into Safe Harbor 401(k) Plans, see our Focus Article on this topic.
IRC §401(k)(12) - Safe Harbor Match and Safe Harbor Non-Elective
Under this Internal Revenue Code, we have 2 basic types of Safe Harbor plans - the Match and the Non-Elective. Both types are unique in their approach but identical in affording owners and highly compensated employees the ability to contribute deferrals (including Roth) into the retirement plan without fear of failing non-discrimination testing.
A Word On Test Failure
In our Primer Article, What’s Non-Discrimination Testing?, we review discrimination and the testing thereof. To recap, a plan provision is discriminatory if it favors HCEs (Highly Compensated Employees) over the NHCEs (Non-Highly Compensated Employees).
In the Average Deferral Percentage (ADP) and Average Contribution Percentage (ACP) test, we examine whether or not the highly compensated employee pools average rate of deferral (or match in ACP) is within acceptable parameters in comparison to the average rate of the non-highly compensated employee pool.
Safe Harbor plans are exempt from ADP, and if applicable, ACP testing as they are deemed to pass. However, this does not mean that the testing is not performed - well for us at Uniglobal anyway.
Your team here tests the plan even if ADP/ACP is deemed to pass (i.e. it’s a Safe Harbor plan). You might ask: “
“Isn’t the whole point of a Safe Harbor plan to not have this kind of testing? Why would you do this?”
And the answers are: Yes, testing is deemed to pass. And, we do this because believe that you and your plan are far better served and informed with the test results.
There may come a time when you no longer want The obligation of having a Safe Harbor provision in your plan. Would your plan pass or fail if it were to be removed? With testing performed, you’ll have a historically record to pull from that could assist you in your decision.
Generally speaking, for Safe Harbor Plans offering only employer Safe Harbor contributions, test failure is nothing you and your HCEs need fear.
Safe Harbor Selection Process
When faced with a decision that involves company assets and employee retirements you’ll want to weigh all options to determine what best suites you and your organization (culturally, fiscally, financially, etc.).
We know you don’t have retirement planning on the brain all day, every day, So, to start you out, we’ve put together a few questions that should work to get things moving in the right direction.
Corporate Culture
This is important to every organization, for profit or not. Your ethos, ideology, dogma, spirit, or whatever you call your culture, it is yours and your employees. With that in mind, ask yourself a few questions about your culture and how it might impact your plan-related decisions:
- How do you define the culture at your company?
- Are your employees collaborative? Independent? On-Site/Off-Site?
- Does Leadership lead with an iron fist from a mountaintop way up high? Or are the leaders in the thick of it with the rest of the staff?
- How would your culture answer the question: “What is best for my employees?”
What Does HR Want? Or, Maybe, What Doesn’t HR Want?
We love HR managers and their teams. These individuals are the wheels that keep the engine moving forward - they are the heart of the company and the voice of your people. Ask these amazing professionals what they would do.
- How are the employees benefiting with a Safe Harbor plan over a non-Safe Harbor plan?
- Does a participant need to contribute from their own pay to share in the employer contribution?
- What are our competitors (and peers) in our industry doing for their employees that we should consider for ours?
Can Finance Back A Required Employer Contribution (and the amount)?
As the song goes, “Money, Money, Monnnaaay,” and no, not the one from that Swedish pop group but the 1974 version. We know you’ve got money on the mind Finance - and that’s OK! We wholeheartedly support it.
Being that Safe Harbor plans require company contributions (whether a Match or a Non-Elective), you might consider asking: “What’s this going to cost?” In addition, might we suggest a few more questions for you?
- When does the company have to come up with the money to fund the plan? Annually? Semi-annually? Every pay period?
- What makes the most sense financially based on total payroll amounts and willingness of participants to contribute?
- The Match could be less expensive than the Non-Elective if we have less than 75% participation, but we’re also looking to allocate Profit Sharing each year. Does the Match really make the most sense?
- If we’re budgeting 8% total, are we committing to the full 8% or something lower?
Options Available Under IRC §401(k)(12) - Safe Harbor Match and Safe Harbor Non-Elective
In the next few sections we are going to highlight key factors that have impacted a decision maker towards one Safe Harbor over the other. These factors may or may not resonate with you, and that is OK.
We are here to work with you and your group, one-on-one. Together, we will find the right solution for you based on your goals and objectives.
Safe Harbor Match
An option for those just starting out with a brand new plan, Safe Harbor Match provides 2 benefits most start-up plans want:
- Owners and HCEs can contribute the maximum AND pass testing, and
- The Match is only provided to participants who actively contribute from their compensation (‘gotta be in it to win it’)
Alternatively, companies with existing retirement plans may need to consider Safe Harbor because of the rate their HCEs are deferring. A plan heavy on HCEs deferring the maximum or close to it could cause test failure which means those HCEs might receive some or all of their deferrals back (if refunds are the elected corrective method). This might not be ideal if you’re trying to save for retirement. The Safe Harbor Match options is a solid choice for existing plans to satisfy testing and provide a company contribution to their participants.
Safe Harbor Non-Elective
The Non-Elective works well for both non-profits and for profits and is ideal for employers looking to provide a benefit to all plan participants, regardless of whether participants are contributing from their pay. In cultures where leadership truly wants to provide a meaningful benefit to their employees who may not otherwise have the means to contribute themselves at this point in time, the Non-Elective is an attractive option.
While there are MANY reasons to select the Safe Harbor Non-Elective, seekers of this type are those that often want:
- To provide an employer contribution to all participants, even if the participants themselves do not defer into the plan,
- To provide additional non-Safe Harbor contributions beyond the 3% minimum,
- (i.e. Contributions that are made at the sole discretion of the company and can have a vesting schedule attached)
In many instances, employers want to provide more to participants. Within a Safe Harbor Non-Elective plan, an employer can not only contribute Profit Sharing on top of the 3% Non-Elective but also contribute a discretionary Match to deferring participants. Those employers offering all 3 types of contributions – Safe Harbor Non-Elective, Discretionary Match and Profit Sharing – have very specific needs they are looking to meet.
The End of an Era
There may come a time when you no longer want the obligation of having a Safe Harbor provision in your plan. Would your plan pass or fail if it were to be removed?
Just because Safe Harbor plans are exempt from ADP/ACP Testing, does not mean that the testing is not performed – well, for us at Uniglobal anyway.
Your team here tests the plan annually even if ADP/ACP is deemed to pass (i.e. it’s a Safe Harbor plan). You might ask:
“Isn’t the whole point of a Safe Harbor plan to not have this kind of testing? Why would you do this?”
And the answers are: Yes, testing is deemed to pass. And, we do this because believe that you and your plan are far better served and informed with the test results.
With testing performed, you’ll have an historical record to reference that could assist you in your decision on whether to stop, suspend, modify or continue the Safe Harbor.