What is a Safe Harbor 401(k) plan? It is recommended that careful consideration be taken . When employers take this step to encourage more employees to participate, the IRS offers them safe harbor from certain nondiscrimination testing processes and the consequences of failure. Basically, Uncle Sam wants to make sure that 401(k)s are set up in a way that doesnt favor highly compensated employees (HCEs) over everyone else. If you're determined to be an HCE after the fact - like after you've made a full 401 (k) contribution for the year - the contribution will have to be reclassified. I had always thought that the deadline for us to deposit the match is the due date of our company tax return (with extensions), but my TPA mentioned something about a quarterly deposit requirement. A safe harbor 401(k) offers significant benefits to workers, including automatic employer contributions to their retirement fund, potential tax deductions and immediate vesting. A safe harbor 401(k) is a type of retirement plan that helps small businessowners accommodate the Internal Revenue Service (IRS) nondiscrimination test. Several types of changes are not permissible during the year, however, so review the rules carefully if you wish to amend your plan. Editor's note: Take care of your retirement and . Highly compensated employees are those who earn more than $130,000 in annual income, those who are employed in the company, and who own at least 5% of the company, or those who are part of a family that owns at least 5% of the company. Here are examples of the different contribution formulas: 1. The administrative hassle it saves is incredible, Azoury says. For a large company, that could be an expensive proposition, but a small business may find it is more cost-effective to make retirement contributions than deal with burdensome nondiscrimination testing. Safe Harbor 401 (k) plans offer employees a pretty sweet deal. All rights reserved. Vesting Schedule If you havequestions, connect with aSmartVestorPro. By setting up a safe harbor 401(k), a business can provide its employees with the same tax benefits as a regular 401(k) plan but skip the onerous annual testing requirements. IRS. If these requirements are at all confusing, wed be happy to help. 3. But dont wait until a few days before the deadline to set up your plan, because if youre making a matching contribution, youre also required to notify your employees 30 days before the plan starts, and it can take a week or more to set up your plan. Another advantage for workers is that employer contributions to safe harbor 401(k) plans are immediately vested. Section 1.401(k)-3(b)(2), and Reg. Find one near you for free and navigate the ups and downs of the market with the help of an investing pro. In 2020, employees can deduct from their taxable income up to $19,500 in contributions to a traditional 401(k) plan of any type. According to the IRS, there are three general nondiscrimination rules traditional 401(k) plans must follow: To show the IRS that a companys 401(k) plan meets those requirements, the plan has to go through a series of annual nondiscrimination tests that are used to figure out whether or not the plan is fairly balanced. This requirement is important because it can help increase savings. Before you learn the basics of safe harbor plans and how they're structured, you must understand the government nondiscrimination testing for regular 401(k) accounts. You will always, however, be 100% vested in your qualified safe harbor contributions if you are employed on or after your Normal Retirement Age. That means you dont have to lose sleep at night wondering if your 401(k) will pass the IRSs tests! The provision must be applied uniformly to all employees. The plan document must be amended to reduce or suspend the safe harbor contribution and to add the required nondiscrimination testing provisions for the plan year: the "actual deferral percentage" ("ADP") test for 401(k) plans and the "actual contribution percentage" ("ACP") test for plans with matching contributions, both of . Maybe youve already set up a 401(k) plan at your workplace, but all the tests and hoops you have to jump through to meet the IRSs rules and standards are driving you nuts. With a standard 401(k), an employee may have to work a certain number of years before they have full access to this money, but no such lengthy predetermined vesting schedule is in place with most safe harbor plans. Larger businesses might have the team and resources in place to keep up with all those requirements, but it can get very time-consuming and expensive for smaller businesses to keep up with. Heres why. After December 1st, you can still add a Safe Harbor nonelective contribution for the year in question, up to the deadline of December 31st of the following year, so long as you increase the contribution to 4%. Its the government verifying that the 401(k) is to the benefit of everyone, explains Dan Beck, CEO of 401GO, a 401(k) platform that specializes in helping small businesses establish their retirement plans. Did you know that most millionaires in America say that putting money in their 401(k) was the key to building their net worth? Market chaos, inflation, your futurework with a pro to navigate this stuff. You are advised to consult a qualified financial adviser or tax professional before relying on the information provided herein. A safe harbor 401(k) plan excludes overtime and bonuses from the definition of compensation. the safe harbor match) that vest immediately. that would be really awkward and uncomfortable for everyone involved. Schedule a quick consult to get hands-on help setting up your 401(k). Safe Harbor contributions are ideal for: Small businesses with employees who do not participate - Highly Compensated Employees can max out their 401(k) contributions even if other employees aren't participating. IRS. One such rule is that plan benefits and contributions must be based on a nondiscriminatory definition of compensation within the meaning of IRC Section 414(s). Your "vested percentage" in your account attributable to qualified safe harbor contributions is determined under the following schedule. In a safe harbor 401 (k) plan, HCEs are therefore able to maximize their salary deferral contributions at the IRS limit (*) without any possibility of an ADP testing failure resulting in "corrective taxable refunds". 401(k) Resource Guide - Plan Participants - Summary Plan Description. Accessed Dec. 2, 2021. Examine the plan document, adoption agreement and all amendments to determine and document in your work papers the various definitions of compensation for, but not limited to: Page Last Reviewed or Updated: 20-Jan-2022, Request for Taxpayer Identification Number (TIN) and Certification, Employers engaged in a trade or business who pay compensation, Electronic Federal Tax Payment System (EFTPS), Treasury Inspector General for Tax Administration, Compensation Definition in Safe Harbor 401(k) Plans, 2013 Phase II Training, Chapter 8, Compensation. 2022 Lampo Licensing, LLC. Theres also less flexibility with a safe harbor plan. Alternatively, the plan can provide that the 3% non-elective employer contribution will be based on Susans compensation for 2016. December 31, 2023: Deadline for adopting a 4% Safe Harbor Nonelective provision to your 401(k) plan with Guideline for the 2022 year (request the amendment by December 1, 2023). Before opening a safe harbor 401(k) plan, employers should seek professional guidance. Learn how to set up a Safe Harbor 401(k) and what problems it can solve for businesses. No employers can match any contribution beyond the four percent threshold. It can pay to shop around when you're looking for a safe harbor. Having a match is really enticing for employees, Gottfried says. The plan can provide that the 3% non-elective employer contribution will be based on Susans compensation for the period of September 1, 2016 to December 31, 2016. Another option is to get assistance from an advisory firm that can determine how a retirement plan fits into the big picture of company finances and goals. Here's a look at the most recent IRA and 401(k) tax reform laws. The company must give all workers instant ownership. Amendments after that time can still be allowed if they increase non-elective contributions by at least 4% for all eligible workers. Advantages include: Tax benefits that can help offset the cost of plan administration. A safe harbor 401(k) plan defines compensation as Form W-2 wages (that is, the amount shown in an employees W-2, Box 1, Wages, tips, other compensation), less reimbursements, fringe benefits, moving expenses, and welfare benefits. A safe harbor 401 (k) plan defines compensation as Form W-2 wages (that is, the amount shown in an employee's W-2, Box 1, Wages, tips, other compensation), less reimbursements, fringe benefits, moving expenses, and welfare benefits. Non-elective contribution: The company contributes at least 3% of each employees compensation, regardless of whether employees make contributions. That would put higher-paid workers in line with those who aren't fully active. More posts from r/personalfinance 17M subscribers methy_butthole 4 days ago These tests compare both plan participation and contributions of rank-and-file employees to owners and managers to make sure the plans are fairly benefitting both groups. Enhanced - Match 100% on the first 4% of compensation. Read our, Definition and Example of a Safe Harbor 401(k). All the details for mid-year changes are included in IRS Notice 2016-16, but these are the basic things the IRS requires: Once youve satisfied the notice rules above, you may be able to make changes to certain aspects of the plan including, for example, increasing future safe harbor non-elective contributions from 3% to 4%, or changing the plan entry date for eligible employees from quarterly to monthly. "401(k) Plan Overview." Contributions are fully vested when they're made. Safe harbor 401(k) plans are typically less expensive to set up than traditional plans. And what do all those acronyms mean? To make sure everyone has a chance to benefit from the plan their employer offers, the IRS has set up a series of what it calls nondiscrimination tests that are designed to measure whether a 401(k) plan unduly favors highly compensated employees. Safe Harbor plans require that you contribute to your employees retirement 401(k) accounts in one of two forms: a match or a nonelective contribution. The third option requires your company to make a contribution, even if employees dont defer any of their income into their plan. The enhanced safe harbor 401 (k) lets employers match 100 percent of employee contributions up to four percent of their paid wages. However, a safe harbor 401 (k) with matching contributions isn't . However, the Safe Harbor 401k is not subject to many of the complex discrimination and compliance rules that are associated with a Traditional 401k plan, including the ADP and Top-Heavy tests. Enhanced- Match 100% on the first 4% of the . Lets run through the benefits and drawbacks of a safe harbor 401(k) really quickly. It's a way to structure a plan that automatically passes the test or avoids it altogether. September 1, 2022: 30-day notice must be sent to employees. Employees who are at least 50 years old have the ability to contribute an. Everything You Need to Know. In addition to the ADP test, an employer can use safe harbor contributions to avoid the ACP test as well, provided these four criteria are met: Matching contributions under the plan may not be based on deferrals that exceed 6.00 percent of pay. Senior insurance needs are different. For instance, with the actual deferral percentage test, or ADP test, if non-highly compensated employees are only putting an average of 4% of their income into their retirement plan, highly compensated employees may be limited to depositing 6% of their income. Top heavy implications . Traditional 401(k) Plan Design. The Actual Contribution Percentage (ACP) test is similar, but it compares employer contributions to HCEs with everyone else. The IRS wants 401 (k) plans to be used by all workers. Reasons to choose a safe harbor 401 (k) plan: The plan will be top heavy. Plans that reduce or suspend safe harbor contributions are subject to separate Treas regulations. The plan must be amended by the last day for paying out excess distributions for the plan year. Our SmartVestor program can connect you with a financial advisor who isready to answer your questions and walk you through all of your options. This Snapshot explores some aspects of IRC Section 414(s) and other compensation issues that are pertinent to safe harbor 401(k) plans. On Dec. 9, 2020, the IRS issued Notice 2020-86 offering guidance for 401 (k) and 403 (b) plans on certain provisions of the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). 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