A good 401k plan is one of the best ways for companies to attract and retain employees. But while 401k retirement plans offer many benefits to employees and employers alike, they also require oversight by the IRS in the form of annual compliance testing.
The three tests administered by the IRS are intended to ensure fairness in company retirement plans so that the HCE’s (Highly Compensated Earners) within the company aren’t reaping all of the benefits of the plan while lower-wage employees are taken advantage of.
In this article, we will provide an overview of how the Safe Harbor 401k plan provision allows you to easily bypass the IRS tests so that you can focus on the more important aspects of your business.
IRS Compliance Tests
In order to guarantee fairness in company retirement plans, the IRS administers three tests each year:
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The ADP Test:
The Actual Deferral Percentage Test ensures that highly compensated earners within a company are limited in the percentage of their wages that can be deferred into their retirement account. This limit is based on the average contribution rates from those employees who are not as well-compensated within the company.
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The ACP Test:
The Actual Contribution Percentage Test looks at the employer end of the spectrum, confirming that employer matching contributions and after-tax contributions by higher-earning employees are proportional to that of the lower-wage employees in the company.
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The Top-Heavy Test:
If the HCE’s within the company maintain more than 60% of the plan balance, your plan is considered top-heavy, and you will fail this test of compliance.
A failure of one or more of these three tests results in hefty fines and tons of paperwork. Therefore, it is always best to avoid even the possibility of failing one of these tests by implementing a Safe Harbor provision in your 401k plan.
How Do Safe Harbor 401k Plans Work?
A Safe Harbor 401k Plan is a way of structuring the retirement plan that automatically satisfies the IRS testing requirements and allows you to move past the testing period each year without a second thought.
Safe Harbor Plans require that companies match employee contributions in one of three ways:
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Basic Matching:
With the basic matching option, employers must match 100% of employee retirement contributions, up to 3% of annual earnings, in addition to matching 50% of the following 2% of employee contributions.
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Enhanced Matching:
Enhanced matching means that employers match 100% or more of each employee’s plan contributions, up to as much as 4% of their yearly earnings.
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Non-Elective Contributions:
As an alternative to the basic and enhanced matching options, non-elective contributions are contributions that are made to all employees’ plans, regardless of whether or not the employees have contributed to the plan themselves. Employers who elect to go the route of non-elective contributions must contribute 3% or more of each employee’s compensation to their plan each year.
How Can I Set Up a Safe Harbor 401k Plan?
If you want to start a safe harbor 401k plan for your business, don’t delay! The deadline to start a new plan is October 1st, 2021. If you are interested in adding a Safe Harbor Provision to an existing 401k plan, the deadline is November 30th, 2021.
