Businesses can bypass the uncertainty, expenses and administrative work of annual IRS compliance testing through the provisions of Safe Harbor plans. The only condition that employers need to fulfill is contributing to the plans of all eligible employees.
How to Design your Safe Harbor 401(k) Plan Contributions
An employer is required to make eligible matching or non-elective contributions to employees as per the requirements of safe harbor 401(k) plans.
- Basic Matching: In this plan, employees are required to defer funds to receive contributions. The employer is required to match 100% of all employee contributions for the first 3% deferred compensation. Employees additionally have to match 50% of deferred compensation between 3% and 5%.
- Enhanced Matching: Same as basic matching, employees are required to defer funds in this plan. The employer is required to match 100% on at least 4% and up to a maximum of 6% of employee contributions.
- Non-Elective Contributions: If employees choose not to make contributions, the employers contribute 3% of the W2 income of the employee.
Points to remember while choosing 401(k) matching
Choosing a 401(k) matching is an employer’s choice and it is important to understand where you are in the business to be able to select the best 401(k) plans. Companies like Ubiquity are best at providing more information on how to make the best selection. Businesses sometimes switch to a matching contribution from a non-elective contribution, thinking low deferral rates will be cheaper. But employees increase their deferrals to receive larger company contributions. If your business goal is to encourage retirement savings then matching can turn out to be best for you. If as an employer, your business goal is cost-savings then a different 401(k) plan might be more suited for you.
Safe harbor matching deposits are required quarterly most often, while non-elective contributions can be made until the last day of the following year. This is another point to consider while designing your 401(k) plans.
How much do Safe Harbor Contributions Cost?
The participation of employees and savings rates affect the total cost of your plan. In some cases, 3% non-elective contributions turn out to be cheaper than the 4% matching plan.
You can calculate the safe harbor contribution for your business using the formula:
Contribution Cost = (No. of employees)*(% of participating employees)*($ average salary)*(% of safe harbor contribution)
Here are some common examples to understand contributions cost. Consider that your average annual salary is $40,000 with 50 employees.
Basic Matching of 4% at 60% employee participation rate: Your employer contribution per year will be $48,000
Basic Matching of 4% with 100% employee participation rate: Your employer contribution per year will be $80,000
3% Non-elective contribution which includes all employees: Your employer contribution per year will be $60,000
What is Non-Discrimination Testing and Benefits of Bypassing IRS Testing?
The government provides significant tax benefits through the 401(k) plans. IRShas mandated annual tests such as ADP, ACD and top-heavy tests to ensure that 401(k) plans to benefit all employees in a company and not just the business owners or highly compensated employees.
Big companies have a higher number of employees contributing to the plan and working at different income levels which allows them to easily pass the non-discrimination test. Small and mid-sized businesses have a relatively higher number of highly compensated employees thereby making it difficult for them to pass the testing.
A safe harbor plan is automatically deemed to pass these crucial ADP, ACP and top-heavy tests. As you can bypass these compliance tests, everyone enrolled in the plan to the maximum contribution limits set by IRS without having to worry about refunds. Also, since employers’ contributions to the safe harbor plans are tax-deductible, it reduces the employer’s taxable income.