Determining the right type of 401(k) plan for your business can be challenging. With so many options and so much to consider, a key decision is whether to go with a traditional or a safe harbor design. This is important as your choice can have long-range implications for your employees and your company.
As an employer, you could be limited in the amount you can personally contribute to the plan under a traditional plan design. On the other hand, a safe harbor plan allows an employer to make a minimum contribution to your employees’ accounts while giving the owner/employees the ability to maximize their personal contributions to the plan. This added benefit may be well worth the potential higher cost of a safe harbor plan. For small companies, the popular safe harbor plan designs can be a win-win for both the owners and the employees.
Although traditional plans allow for both employee and employer contributions to employee accounts, the amounts for employees who are considered highly compensated are restricted depending on income. A traditional plan is required to be tested ensuring employees considered highly compensated are not disproportionately advantaged in the plan.
With a safe harbor plan design, employers can match employee contributions or make non-elective safe harbor contributions without many of the Department of Labor/IRS regulations that come with traditional plans.
A safe harbor plan is an attractive alternative for the business that wants the benefits of a 401(k) plan but does not want to or is not able to satisfy the required annual compliance testing. It’s a very good option for family-based businesses that can meet the required criteria.
Safe harbor plans can have several advantages:
- Allow owners and other highly compensated employees to contribute the maximum annual deferral amount into their own accounts.
- Under a safe harbor plan, top-heavy rules and discrimination testing are avoided for salary deferrals and employer contributions meeting the safe harbor provisions. This limits the effects from IRS non-discrimination testing and top-heavy.
To get the advantages a safe harbor plan offers a plan must meet several criteria in order to qualify such as employee match. Make sure you review these criteria before selecting safe harbor.
As attractive as a safe harbor plan sounds, there are some downsides when considering a safe harbor plan verses a traditional 401(k) plan:
- If your business has inconsistent revenue streams, it may be difficult to maintain year-round matching or Non-Elective contributions.
- Safe harbor plans can be more expensive than a traditional plan.
- Safe harbor matching or Non-Elective contributions are vested 100% immediately.
- A safe harbor plan must be set up 3 months prior to the plan year end date which means the deadline for 2016 is fast approaching.