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Traditional 401k or Safe Harbor 401k |
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Two 401k Types
A traditional 401k, also known as simply a 401k, is still the most popular type of defined contribution retirement plan in the US, today.
At the same time over the last few years, many more small businesses owners have implemented the alternate design, a Safe Harbor 401k.
Businesses that can afford the required employer contributions under a Safe Harbor 401k, have found this option to be most appealing.
A Safe Harbor 401k does not have the same discrimination and top heavy testing as a traditional 401lk.
Accordingly, a Safe Harbor 401k is generally easier to administer and therefore has lower record keeping and administrative fees each year.
Selection and design are essential first steps in retirement plan implementation, so both Traditional and Safe Harbor options should be examined upon your initial review.
Safe Harbor 401k Or SIMPLE
A small business owner making the decision to implement a Safe Harbor 401k, with a matching provision, should also consider the benefits of a SIMPLE.
In instances where employees would be saving up to, yet not exceeding SIMPLE limits, a SIMPLE may be a better fit.
Like a Safe Harbor 401k with matching, a SIMPLE has a required employer matching condition, and no non-discrimination testing. The maximum employer outlay is slightly less for a SIMPLE than the amount for a Safe Harbor 401k – in a SIMPLE, the employer must match the employee's elective deferrals up to 3% of the employee's pay for the year (in a Safe Harbor 401k, the limit is 4%).
On the other hand, in cases where some employees would take full advantage of maximum permitted deferrals, a Safe Harbor could be the better option because it allows higher deferrals.
The value of that deduction plus the future tax-deferred growth on the additional contribution may outweigh any additional administrative expense of a 401k vs. a SIMPLE.
Primary Differences
While a Traditional 401k does not require an employer matching contribution, it is subject to non-discrimination testing including ADP (Average Deferral Percentage) and top heavy testing.
A Traditional 401k is considered top heavy when more than 60% of the plan assets are in the accounts of the key employees. Many small businesses, including closely held companies, family owned organizations, and entities with large differences in compensation, face difficulty with top heavy testing.
If a plan is top heavy, it must meet special minimum employer contributions and vesting.
Since a Safe Harbor 401k does not have these same testing requirements, this is the central attraction when an employer selects Safe Harbor 401k over the design of a Traditional 401k.
Selecting A Plan
A Safe Harbor 401k combines some of the best features of a Traditional 401k along with attributes of other retirement plans that do not require testing. The reason is that a Safe Harbor plan, operating within guidelines, is deemed to pass ADP/ACP non-discrimination testing.
Within a Safe Harbor 401k, employees have the opportunity to make elective contributions on a pre-tax basis (salary deferral) and receive a fully vested 4% employer matching contribution.
In a Traditional 401k, employees may save up to the annual IRS deferral limit (not more than 100% of pay), unless the employee is a Highly Compensated Employee (HCE).
In the case of HCEs, these participants are limited in their permitted deferral percentage based on Average Deferral Percentage testing.
Each employer's demographics, financial situation, and plan design goals form a unique scenario which should be discussed with the proposed provider before finalizing a decision for Traditional 401k or Safe Harbor 401k.
Each of these variables, including then number of employees, covered payroll, and probable average savings rate play a large part in the most suitable plan design.
During your review, our team can provide the record keeper’s illustration of both a Traditional 401k and Safe Harbor 401k, if you would provide a current census.
For more information relation to illustration options, please contact us at:
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or call Toll Free (888) 552 7284 x 3014.
This notice provides additional guidance regarding 401k plans that are intended to be Safe Harbor: IRS Notice.
Key Features
This content explores significant elements of a Safe Harbor 401k along with smart design strategies.
A table comparing a Traditional 401k vs. Safe Harbor 401k is available here:
Retirement Plan Types & Contribution Limits.
Primary differing features include the following:
Traditional 401k | Safe Harbor 401k |
| Annual ADP Testing Applies | No ADP Testing |
| Top Heaving Testing | No Top Heavy Testing |
| Annual Deferral Limit $16,500 (in 2011) | Same |
| Annual Catch-Up Limit $5,500 (in 2011) | Same |
| Matching Is Completely Flexible | Safe Harbor Match Required
(If Basic Or Enhanced Match Selected)
100% Up To 3%
+ 50% Between 3% To 5% Of Pay
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| Profit Sharing Is Completely Flexible (Unless Top Heavy) | Non-Elective Contribution
(Instead Of Match) |
| Vesting May Be 6 Year Graded Or 3 year Cliff | Safe Harbor Employer Contributions 100% Immediately Vested |
| Plan Establishment Deadline
By the last day of
the plan year | October 1
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A Traditional 401k plan offers the maximum flexibility of the two types of plans. Employers have discretion to make contributions on behalf of all participants, to match employees’ deferrals, or do both. These contributions can be subject to a vesting schedule or immediately vested at the employer’s choice. When contributions overall are limiting owners/executiives’ intended contributions (due to ADP testing), a Safe Harbor 401k is a better design.
Safe Harbor Rules
Adoption Of Plan
Special rules require that the plan be adopted at least 30 days prior to the beginning of the Plan Year. For Calendar Year Plans, you should adopt the plan initially in October or November prior to the effective date.
Employee Notification
All eligible employees must be given an Annual Safe Harbor Notice at least 30 days and no more than 90 days prior to the beginning of EACH Plan Year. New employees must be given a Safe Harbor Notice and a Summary Plan Description prior to their eligibility date.
Eligibility
The Plan can require employees to wait up to 1 year of service (12 months with 1,000 or more hours of service) and be at least age 21 in order to meet eligibility. If the waiting period is less than 1 year, there can be no minimum hours-worked requirement under the IRS Code to keep employees from becoming eligible. You may utilize a shorter waiting period or waive the eligibility requirements entirely (which is common).
One year of service is defined as follows: The first year is the first 12 months of employment and each subsequent Plan Year after the employee’s hire date. An employee must work 1000 hours during an eligibility year in order to have 1 year of service.
Top Heavy And Non-discrimination Testing
Safe Harbor plans are automatically exempted from both the top heavy rules and
non-discrimination testing go long as there are no additional contributions made by the employer other than the Safe Harbor Contribution. If an employer wants to
make additional contributions, we recommend the Non-Elective Safe Harbor.
Vesting
Safe Harbor contributions are always 100% vested. Non-Safe Harbor contributions may be subject to a vesting schedule as permitted by the IRS.
Vesting service is defined as any Plan year in which the employee is credited with 1,000 or more hours of service.
Employee Contribution Limits
Employee elective deferral limits are indexed annually and in 2011 the maximum is $16,500 plus $5,500 additional for any person age 50 or over.
Employer Contribution Limits
The employer is permitted to make flexible contributions (after the required minimum as detailed).
In 2011, the limit is 25% of an employee’s pay, not to exceed $49,000.
Contribution Election
When a Safe Harbor 401k design is selected, the employer must choose one of two general options for making contributions to employee accounts. While the option may be changed from year to year, one or the other is necessary.
Both of these options require the contributions to be fully vested.
The two options are:
- Matching Option (Basic or Enhanced)
- Non-Elective Option (3%)
If the matching option is elected, there are two types, Basic and Enhanced.
Under either formula, the employer matches at least 100% of non-highly compensated employees (NHCE) salary deferral up to 3% of the employee's compensation, plus 50% of the NHCE's deferral between 3 to 5% of compensation. This translates into a 4% matching contribution for employees deferring 5% of compensation or more. Employees making no deferral would receive no match.
The alternate option is designed for an employer who wishes to contribute to all eligible employees, regardless of their deferring compensation.
This is known as a non-elective employer contribution.
Matching Option (Basic)
Summarized Rules:
- Basic match is 100% of first 3% deferred, plus 50% of next 2% deferred.
- Basic match is 100% vested.
- No Allocation Requirement may be imposed, such as 1,000 hours or last-day-of-plan-year rule.
- Not available for hardship or in-service withdrawals before age 59½.
Matching Option (Enhanced)
Summarized Rules:
- Matching formula must be at least as generous as Basic match formula.
- Rate of match may not increase as deferral percentage increases.
- Basic match is 100% vested; additional match may have vesting.
- No Allocation Requirement may be imposed, such as 1,000 hours or last-day-of-plan-year rule.
- Not available for hardship or in-service withdrawals before age 59½.
Note: Plans using either the Safe Harbor Basic or Enhanced matching formula, provided there is no allocation of any other employer contributions including reallocation of forfeitures, are exempt from the top heavy rules.
Non-Elective Option (3%)
Summarized Rules:
- Any employee who meets eligibility requirements receives 3% of pay as an employer contribution.
- Non-elective contribution is 100% vested.
- No Allocation Requirement may be imposed, such as 1,000 hours or last-day-of-plan-year rule.
- Not available for hardship or in-service withdrawals before age 59½.
- The 3% non-elective contribution can be counted in a cross tested profit sharing formula, but cannot be used for purposes of permitted disparity.
This option works similarly to a Profit Sharing contribution in that any employee who meets the plan’s eligibility requirements receives a 3% of pay contribution.
One difference from a Profit Sharing plan is that employer non-elective contributions are always 100% vested immediately at the time of deposit.
A plan that only permits elective deferrals and contributions that satisfy the ADP and ACP safe harbor provisions is exempt from the top-heavy rules. To be exempt, there cannot be any other employer contribution (i.e., profit sharing contribution) and forfeitures cannot be allocated on a basis other than as a match that satisfies the ACP safe harbor.
Combining A Safe Harbor Plan With A New Comparability Profit Sharing Plan
A Safe Harbor 401k may be combined with a New Comparability Profit Sharing plan.
The combined plan is sometimes referred to as a SuperComp plan.
A New Comparability Profit Sharing plan contains an allocation formula that favors a certain class of employees.
The amount contributed to this target group, typically owner(s), officers or key executives, can be higher than the percentage contribution for other employees.
The Safe Harbor component of a SuperComp plan permits maximum deferrals without regard to non-discrimination testing.
Together, these two components can create favorable advantages for both the business and certain higher paid employees and owners intending to accumulate needed retirement capital, without testing limitations.
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Important Information
All administrative and record keeping services are offered by PB&H Benefits, LLC.
The custodian trust company is Mid Atlantic Trust Company (MATC), providing a state-of-the art trading and reporting system that integrates record keeping, trust accounting, and straight-through processing with access to over 16,000 mutual funds in underlying accounts.
All investments are offered by Registered Representatives of MML Investors Services, LLC, Securities are distributed through MML Investors Services, LLC, Member, SIPC. Supervisory Office: 2 Bala Plaza Suite 901 Bala Cynwyd, PA 19004 Tel (610) 660 9922.
Investment education is provided by Registered Representatives of MML Investors Services, LLC.
Note that our role as financial professionals, with respect to the 401k plan, is not to provide investment advice. We offer employee education including fund information and portfolio design using models that match the employee's intended level of risk and investment goals.
In no way do we endorse any recommendations, advice, or opinions contained in Information developed by third party providers and mentioned in this website. We merely provide access to such information as a convenience to help you consider your design and investment selections. Any investment decisions you make are based solely upon your evaluation of financial circumstances and investment objectives, in the best interests of your Plan.
Mutual Funds are sold by prospectus. You should carefully consider a fund’s investment objectives, charges, expenses, and risks before investing. The fund's prospectus, which can be obtained online (or hard copy) by calling your Registered Representative, contains this information and other facts about the fund. Please read the prospectus carefully before you invest or send money.
We do not offer tax planning or legal advice. Please consult your CPA or attorney for specific tax implications and legal matters pertaining to your Plan.
Registered Representative Information
John M. Novak is a Registered Representative of and offers securities and investment advisory services through MML Investors Services, LLC, Member, SIPC.
Supervisory Office:
First Financial Group
2 Bala Plaza Suite 901
Bala Cynwyd, PA 19004
Tel (610) 766 3014
Administrative and record keeping services offered by PB&H Benefits, LLC, and custodian services offered by Mid Atlantic Trust Company are not sponsored or offered through First Financial Group or MML Investors Services, LLC. PB&H and MATC are not affiliates or subsidiaries of MML Investors Services, LLC.
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