A Overview of Types of Safe Harbor 401(k) Plans

A safe harbor 401(k) plan will eliminate the antidiscrimination testing that often results in the highly paid employees being limited in the amount they can do as salary deferrals. Safe harbor plans must be 100% vested, issue an initial and annual notice and consist of certain required contributions by the Plan Sponsor and you cannot have any allocation conditions such as having to be employed on the last day of the Plan Year.

Traditional Safe Harbors

The Plan Sponsor can make a contribution of a minimum of 3% of compensation to all eligible employees whether they are doing personal salary deferrals or not. This method is the one that should be used if the Plan Sponsor is making additional Profit Sharing contributions to allocation groups (under the "cross-tested method").

Another method is a minimum matching contribution of a 100% match on the first 3% of compensation and a 50% match of contributions above 3%. However no match is required for salary deferrals in excess of 5%. In other words, if an eligible participant does salary deferrals of 3% of his or her compensation, the Plan Sponsor would make a 3% matching contribution. If the participant contributes 5% or more of his or her compensation, the Plan Sponsor would make a match of 4%. If the participant were to contribute 4% of his or her compensation, the Plan Sponsor would make a matching contribution of 3.5% of compensation. Alternatively the Plan Sponsor can have a matching formula of 100% of salary deferrals of up to 6% of compensation. For example, the safe harbor match could be 100% of deferrals of up to 4% or 100% of deferrals of up to 6%, etc. This is called an "Enhanced Safe Harbor Match".

The safe harbor contribution must be 100% vested. Profit Sharing contributions over and above the safe harbor can be subjected to a vesting schedule.

Qualified Automatic Contribution Arrangement (QACA) Safe Harbor

The QACA safe harbor is similar to the traditional safe harbor match but the QACA contribution for Plan Sponors is a minimum match of 100% on salary deferrals up to 1% of compensation and 50% on deferrals between 1% and 6%. At most salary deferral levels, this approach can save the Plan Sponsor a full 1% in matching contributions. Plan Sponsors may alternatively make a 3% contribution to each participant, regardless of whether the participant makes contributions to the plan.

A QACA must also involve automatic enrollment of a minimum of 3% of compensation from the participant’s entry date and through the next full plan year. This rate is generally increased by 1% each plan year until participants contribute 6% of compensation to the plan. Employees can, of course, elect a different salary deferral amount or even elect not to have any salary deferrals. QACA safe harbor contributions must fully vest within two years.

How does a QACA match compare with the older Basic Safe Harbor match?  At 1% of salary deferrals the match for both is 1%.  At the 2% level, the match for a QACA is 1.5% vs. 2% (or 25% less).  At the 3% salary deferral level the match for the QACA is 2% vs 3% for the Basic (or 33% less).  At the 4% level of deferrals the QACA match is 2.5% vs 3.5% for the Basic match (or 28% less).  At 5% in deferrals, the QACA is 3% vs 4% for the Basic match (or 25% less expensive).  Even at the 6% level, the QACA match is maxed out at 3.5% vs the Basic match max of 4% - so it is 12.5% less expensive (0.5% difference divided by 4% = 12.5%).  This potential savings could be a real door opener for the Advisor who searches 5500's for plans that probably have a Basic Safe Harbor Match.
Some Additional Points About Safe Harbor Plans

An existing 401(k) Plan cannot become a Safe Harbor Plan during the Plan Year. It can be amended into a Safe Harbor as of the first day of the next Plan Year. You need to plan ahead because a Safe Harbor Notice should be issued 30 days before the new Plan Year starts. A new 401(k) Plan can start as late as October 1 (for a Calendar Year Plan) and still be a Safe Harbor plan for the first short year.

Roth 401(k) contributions can be made to a Safe Harbor 401(k).

If you have any questions about how Safe Harbor 401(k) Plans work, please me (Paul Carlson) at (650) 425-7912. I would be delighted to help.

Ideal Retirement Plan Design for Very Small Employers

CPA's should be aware of a special retirement plan design approach that their small clients might find very effective in slanting the plan in favor of the business owner.

For a business owner over age 45, one of the best designs for a 401(k) Plan if there are a number of younger employees (as compared to the age of the owner), would be a "Safe Harbor Cross Tested 401(k) Plan."

The way this may be able to work in 2014 for your client is a 4.4% of pay contribution for the non-owners (consisting of a 3% Safe Harbor and a 1.4% additional Profit Sharing).  This will allow the business owner to do either $17,500 or $23,000 in Salary Deferrals (depending upon whether or not they are 50 years of age by the last day of the year) plus $34,500 in Profit Sharing for the $57,500 limit. This assumes the business owner is making over $260,000 in salary or income after all contributions and that the allocations pass certain discrimination testing based on projected benefits.  Not bad - 13.3% Profit Sharing allocation for the owner or partners while only doing 4.4% for support staff.

Should the owner be able to afford more than the $57,500, they should consider using a 401(k) Cash Balance Combo Plan where an owner in their 50's might be able to put away an additional $100,000 to $180,000 depending upon their age.

Have the client submit census information consisting of name, date of birth, date of hire, ownership and annual compensation estimate to us and we can do a no cost illustration.  There is a strong possibility that the change could still be implemented for 2014 - depends upon some current plan document language.