Is a safe harbor plan right for your small business?

Is a safe harbor plan right for your small business?


Determining the right type of 401(k) plan for your small business can be challenging. With so many options and so much to consider, one key decision you may have to make is whether to go with a traditional plan design or a safe harbor plan design. This is a vitally important decision, as your choice can have long-term implications for both your employees and your company.

Key differences between traiditional 401(k) plans and safe harbor plans

As an employer, you could be limited in the amount you can personally contribute to a traditional 401(k) plan. On the other hand, a safe harbor plan allows an employer to make a minimum contribution to their employees’ accounts while giving the owner and highly compensated 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 design can be a win-win for both owners and employees.

Although traditional 401(k) plans allow both employees and employers to contribute to employee accounts, the amount highly compensated employees can contribute may be restricted by maximum income and discrimination testing limits. Traditional plans are required to be tested to ensure highly compensated employees are not disproportionately advantaged in the plan. But 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 businesses that want the benefits of a 401(k) plan but do not want to, or are 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.

Benefits of safe harbor retirement plans

Safe harbor retirement plans can have several advantages. For starters, they allow the business owners and other highly compensated employees to contribute the maximum annual deferral amount into their own accounts while bypassing some of the regulated plan testing. Top-heavy rules and discrimination tests are avoided for salary deferrals and employer contributions as long as they meet the safe harbor provisions. This limits the effects commonly felt from IRS top-heavy and non-discrimination testing. These perks may help reduce your business taxes and help your employees build a larger nest egg all at the same time.

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Safe harbor retirement plans vs. traditional retirement plans

As attractive as a safe harbor plan sounds, there are some downsides when considering a safe harbor plan versus 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 traditional plans.

  • To get the advantages, safe harbor plans must meet several criteria just to qualify, including required employer contributions, mid-year amendment restrictions, and notice requirements. Make sure you review these criteria before selecting safe harbor.

  • Safe harbor matching or non-elective contributions are vested 100 percent immediately.

  • A safe harbor plan must be set up 3 months prior to the plan year end date.

Advance preparation and planning is always necessary in order to establish a new tax-qualified plan or redesign an existing one. The same holds true for safe harbor plan design. Making an informed choice starts with asking the right questions and understanding the benefits and drawbacks of your retirement plan options.

Not sure if Safe Harbor is right for your company? A needs assessment can help you determine the best path. Contact us today to learn more at 800.236.7400, option 1!