The term “safe harbor” has a multitude of meanings in conjunction with the administration of qualified retirement plans. But in recent years the term has predominantly been associated with the provisions applicable to safe harbor 401(k) plans. These plans have become extremely popular, especially among smaller employers. And when you consider the overall benefits, it’s no surprise.
One advantage of 401(k) plans to employers is that the employees bear at least a portion of the cost of their retirement benefits. A drawback is the rigorous nondiscrimination testing that must be performed each year, as well as the possible remedies for a failed test, such as corrective distributions. A safe harbor plan eliminates the need for nondiscrimination testing! That alone would justify the safe harbor option in many situations. But there are other benefits as well, and you will want to know all of them.
What is a Safe Harbor 401(k) Plan?
The basic principle of a safe harbor 401(k) plan is that a certain minimum contribution is provided by the employer in exchange for being able to eliminate deferral (ADP) and matching (ACP) nondiscrimination testing. The benefit of eliminating the testing is that highly compensated employees (HCEs)–generally more than 5% owners and those earning over a specified threshold in the prior year ($95,000 in 2005)–can defer up to the annual limit without concern for what the non-HCEs defer.
Under the normal 401(k) plan rules, the average deferral percentage allowed for HCEs is slightly higher (generally 2%) than the average percentage deferred by non-HCEs. For 2005, the maximum deferral allowed per participant is $14,000, with an additional $4,000 allowed as a catch-up contribution for those age 50 and older. Consider the following example:
Susanne and Alex each own 50% of the ABC Company which has three other employees. Susanne and Alex are both under age 50 and earn $100,000 each. In 2004 the three other employees deferred an average of 5% of compensation into the plan. Using the prior year testing method, Susanne and Alex, as the only HCEs, would be allowed to defer an average of 7% into the plan in 2005, which would be $7,000 each. However, if the plan were a safe harbor plan, they could each defer the maximum $14,000 since no testing would be required. That’s an additional $14,000 between the two of them!
Establishing the Plan
In general, a safe harbor 401(k) plan must be in effect for the entire plan year and adopted before the plan year begins. A midyear adoption is permitted for a new 401(k) plan as long as the initial plan year is at least three months long. The initial plan year can be reduced to as little as one month for a newly established company. Midyear adoption is also permitted for an existing non-401(k) profit sharing plan that is amended during the year to include safe harbor 401(k) provisions as long as it is effective for at least the final three months of the plan year.
Notice Requirement
Eligible employees must be provided with a safe harbor notice within a reasonable period before the beginning of the plan year. The notice is automatically deemed to be timely if it is distributed at least 30 days and no more than 90 days prior to the beginning of the plan year.
The notice must contain participants’ rights and obligations under the plan. It should include the type of safe harbor contribution being offered, any other contributions to be made, procedures for making deferral elections, withdrawal and vesting provisions of the plan as well as other detailed information as specified in the regulations. Some of the information can be incorporated by reference to the plan’s summary plan description.
As an alternative to the standard safe harbor contribution commitment, a plan can provide that a conditional notice (referred to as a “maybe” notice) be distributed, stating that the employer may make a safe harbor nonelective contribution (discussed below). A follow-up notice is required to be given out by the beginning of the last month of the plan year stating whether or not such contribution will be made. If not, the nondiscrimination tests will have to be performed for that year. This gives the employer the ability to delay the decision until the needs of the company can be considered.
Plan Document
When establishing a safe harbor plan, the plan document must state whether it intends to be a guaranteed safe harbor or a potential safe harbor that will distribute the “maybe” notice. It can’t allow for complete flexibility to be dependent upon the type of notice, if any, that is given out each year.
Safe Harbor Employer Contributions
Employers may choose between two types of contributions: a safe harbor nonelective contribution or a safe harbor matching contribution. These contributions must be 100% vested and are not available for hardship or other in-service withdrawals before age 59½. No minimum hours of service can be required, and a participant cannot be required to be employed on the last day of the plan year.
Nonelective Contribution
The nonelective contribution requires the employer to contribute 3% of each eligible employee’s compensation for the year. For an employee’s initial year of participation, compensation prior to plan entry can be excluded.
The safe harbor nonelective contribution can be made to another qualified plan maintained by the employer, which must be stated in the notice.
Matching Contribution
The basic safe harbor matching contribution requires the employer to match elective deferrals at the following rate: 100% of the first 3% of compensation deferred, plus 50% of the next 2% deferred.
Alternatively, the employer may contribute an “enhanced” match which is greater than that required by the basic match. Under the enhanced match, the contribution rate cannot increase as an employee’s deferral rate increases, and the contribution rate for HCEs cannot exceed the contribution rate for non-HCEs.
A plan may allow additional matching contributions on top of the safe harbor match. The plan will still be exempt from nondiscrimination testing if the following requirements are met:
- If the additional match is discretionary, it does not exceed 4% of compensation, and
- The match is not made on deferrals above 6% of compensation.
Matching contributions that do not meet the safe harbor rules must be tested, even if the 3% nonelective contribution is made.
The safe harbor match may be discontinued during the year if a written notice is provided to participants at least 30 days in advance. In such cases, the plan reverts to non-safe harbor status and must perform the nondiscrimination tests for the entire year.
Impact on Other Plan Requirements
Now that you understand how safe harbor plans eliminate ADP and ACP nondiscrimination testing, you will want to know the additional advantages they provide in top heavy plans and cross-tested profit sharing plans.
Top Heavy Plans
A plan is considered top heavy if the account balances of the key employees (generally owners and certain officers) exceed 60% of the total account balances under the plan. These plans are required to provide a minimum employer contribution to all non-key employees of at least 3% of compensation if any key employee receives a contribution of 3% or more (including deferrals).
Plans that meet the safe harbor requirements are exempt from the top heavy rules unless one of the following applies:
- The employer makes a contribution to the plan other than deferrals or the safe harbor contribution (such as a discretionary profit sharing contribution). Additional match contributions that stay within the safe harbor guidelines can be made without eliminating the top heavy exemption;
- Forfeitures are allocated as additional contributions during the plan year; or
- The eligibility requirements for elective deferrals are more liberal than for safe harbor contributions, so that some eligible employees do not receive the safe harbor contribution.
Where the plan does provide more liberal eligibility for making elective deferrals, nondiscrimination testing must be performed for the group not eligible for the safe harbor contribution. If no HCEs are included in this group, the tests will automatically pass.
Even if a plan is not exempt from the top heavy rules, safe harbor contributions can be used towards satisfying the top heavy minimum contribution. In most cases, the 3% nonelective contribution will satisfy this requirement. If the safe harbor match is utilized, these contributions can help reduce the top heavy contribution.
Cross-Tested Plans
An additional benefit of the 3% nonelective contribution is that it can be used towards the minimum gateway allocation required in cross-tested plans (also called “new comparability plans”). These plans factor in participants’ ages and can often provide a large contribution for certain key participants with minimal contributions for others.
Here is an example of an ideal situation in which a 3% safe harbor contribution is used to satisfy the nondiscrimination requirements, the top heavy requirements and the cross-tested gateway contribution:
| Employee | Compensation | Deferrals | 3% Employer Contribution |
Additional Employer Contribution | Total |
| Owner A | $200,000 | $18,000* | $6,000 | $12,000 | $36,000 |
| Owner B | 200,000 | 18,000* | 6,000 | 12,000 | 36,000 |
| Staff C | 50,000 | ? | 1,500 | 0 | 1,500 |
| Staff D | 40,000 | ? | 1,200 | 0 | 1,200 |
| Staff E | 30,000 | ? | 900 | 0 | 900 |
| $520,000 | $36,000 | $15,600 | $24,000 | $75,600 | |
| *Includes $4,000 catch-up contribution since over age 50. | |||||
The total employer contribution provides 3% for the staff and 9% for the owners, which satisfies the gateway since the higher percentage is not more than three times the lower percentage. This example assumes that the overall contributions satisfy the cross-testing requirements which are dependent in part on the ages of the participants.
This plan allows the owners to contribute $72,000 for themselves at a cost of only $3,600 for their employees, which is over 95% of the total. Employees can also defer a portion of their compensation.
The plan will likely be top heavy and is not exempt because of the additional employer contribution. But the 3% contribution satisfies the top heavy requirement.
Conclusion
A safe harbor 401(k) plan can provide a variety of benefits to employers as compared to a traditional 401(k) plan. Employers who intend to provide some level of matching or profit sharing contribution may find that a small increase in contributions for the staff goes a long way. Safe harbor contributions can also be used to satisfy top heavy as well as cross-tested contribution requirements. As a result, safe harbor provisions often enable employers to get the most value out of their 401(k) plans.
This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.
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Spring will arrive soon, promising new growth and a fresh beginning. It could also be the perfect time to do some spring cleaning for your plan. Let’s look at some areas that you might consider reviewing to ensure your retirement plan is operating efficiently.
Document your processes and procedures to make certain that plan tasks can be handled in case of any absences during an enrollment or pay period. Having a backup in place can prevent errors and delays that could lead to penalties.
Make sure to have a process in place to notify all new enrollments of their eligibility, regardless of whether the plan has automatic enrollment. Depending on the timing for plan entry, including the plan enrollment paperwork with the new hire paperwork could make entry easier for you. Please reach out with any questions regarding when an employee enters the plan.
Deposits of employee deferrals and loan repayments must be submitted to the plan as soon as possible to avoid penalties and corrections. For plans with less than 100 participants, a safe harbor rule allows deposits to be made within seven business days. For larger plans, the expectation is that the money will be deposited more quickly. Depositing these funds on the pay date will avoid the possibility of being late.
Monitoring deferral contribution limits during the calendar year will avoid refunds after year end. Make sure that your payroll is set up to stop deferrals once the limit is reached, including any catch-up contributions for those who have reached age 50.
To keep the plan in compliance, employer contributions must be deposited timely. Due dates are impacted by the type of contributions, required status and tax deductibility. If you have questions on when to deposit your employer contribution or even whether to make an employer contribution, please contact us.
Most plans must be covered by a fidelity bond. The minimum coverage is 10% of plan assets (rounded up to the next $1,000) and the maximum coverage is $500,000. Additional requirements apply to plans with employer securities or non-publicly traded assets. If your fidelity bond is insufficient, now is the time to raise the coverage. Inflation clauses that increase the bond amount as the plan assets increase can ensure that your bond coverage is always adequate. Contact us or your insurance provider if you don’t have a fidelity bond.
Another area to review is communication with participants. Helping your employees understand and trust the plan can increase their contributions. Be sure that your procedures include distributing any plan-related communications—including required participant notices.
Distributions also involve communication, including some of the aforementioned notices. Discussing distribution options with terminated participants, possibly as part of an exit interview, can help to reduce risk of lost participants. We’ll provide instruction on distributions for force-out distributions for small balances, testing corrections and required minimum distributions.
Your plan document is the legal source on how the plan should be administered; operating within its parameters is critical. It’s always worth taking time to review the plan document to ensure that you fully understand and are following its provisions. We’ll cover more details about the plan document later in this newsletter. We’re here to support you in keeping your plan in compliance. Please feel free to reach out with any questions.
Addressing the Challenge of Uncashed Distribution Checks
Uncashed distribution checks present a persistent and often overlooked challenge for retirement plan sponsors. Despite the best efforts of plan administrators, some participants fail to cash their distribution checks, leading to administrative burdens, fiduciary concerns and potential compliance issues. A recent publication by Retirement Management Services (RMS) sheds light on this issue and offers practical guidance for employers seeking to manage and mitigate the risks associated with uncashed checks.
Uncashed checks can arise for various reasons. Participants may have moved without updating their contact information, may not recognize the check as legitimate or may simply forget to deposit it. Regardless of the cause, the responsibility for addressing these uncashed funds ultimately falls on the plan sponsor. This creates a fiduciary obligation to act in the best interest of the participant while ensuring compliance with IRS and Department of Labor (DOL) regulations.
Sponsors are encouraged to maintain up-to-date contact information for all plan participants and to follow up promptly when checks remain uncashed. This may involve sending reminder letters, making phone calls or using certified mail to confirm receipt. In some cases, plan sponsors may also consider using electronic payment methods to reduce the likelihood of checks going uncashed in the first place.
The IRS and DOL have issued guidance on how to handle these situations, including the use of forfeiture accounts and escheatment to state unclaimed property programs. However, these options come with their own set of rules and potential pitfalls. For example, using a forfeiture account may require the plan document to explicitly allow for such treatment. Escheatment laws, which allow the government to assume control of unclaimed property, vary by state. As such, plan sponsors must carefully evaluate their options and consult with legal or compliance experts as needed.
Another important consideration is the documentation of all the efforts made to contact participants and resolve uncashed checks. Maintaining a clear audit trail can help demonstrate fiduciary prudence and protect the plan sponsor in the event of an audit or legal challenge. It is extremely important to have a written policy in place that outlines the steps to be taken when a check remains uncashed beyond a certain period.
By taking a proactive, well-documented and compliant approach, employers can fulfill their fiduciary duties, reduce administrative burdens and ensure that participants receive the benefits they are entitled to.
Source: Retirement Management Services – “Uncashed Distribution Checks” https://www.consultrms.com/Resources/59/Plan-Sponsor-Tips-and-Help/212/Uncashed-Distribution-Checks
Divorce and the Retirement Plan
When a participant in a qualified retirement plan undergoes a divorce, the participant’s account balance may be an asset that is split with the former spouse. As the plan exists for the exclusive benefit of its participants, a court order is required to transfer the participant’s benefits to the ex-spouse. Once approved by the plan administrator, this court order is called a Qualified Domestic Relations Order (QDRO).
The QDRO is a judgment, decree or order that must be issued by a state authority (usually a court). It can be part of the divorce settlement or it may be a separate document. Because of the serious nature of separating the participant’s account balance, the QDRO is more than just an agreement made by both parties — it must also be signed by a judge.
A QDRO will describe how to divide the participant’s account balance between the participant and the ex-spouse, referred to as the alternate payee. In some cases, a set dollar amount will be allocated; in others, a percentage of the account may be designated. In the latter case, the amount assigned to the alternate payee represents the given percentage of the participant’s total vested account balance as of a specified valuation date. This percentage will apply to all sources — such as deferrals, matching or profit sharing — unless specified by the QDRO. Any interest and investment gains/losses that accrue between this valuation date and the date the funds are separated into an account for the alternate payee are often factored into this final calculation. If the participant has outstanding loans, the QDRO will usually indicate how the loans are handled.
Contributions such as deferrals and employer matching made after the valuation date are credited to the participant’s account. Earnings and losses are applied to the account balances. Once the division is complete, the alternate payee’s portion (either dollars or shares) is transferred to an account in the alternate payee’s name.
If the plan allows, the alternate payee may be paid out in a cash or rollover distribution. Not all plan documents allow the alternate payee to receive a distribution before reaching normal retirement age, so it’s important to follow the terms of the plan. In addition, the QDRO cannot violate the provisions of the plan document by requiring a plan to provide an alternate payee or participant with any type or form of benefit not otherwise provided under the plan.
Although the most common situation for a QDRO is a divorce, it can be issued in other situations, such as to a dependent in the case of child support. If the alternate payee is a minor child or legally incompetent, the order can also require payment to the individual with legal responsibility for the alternate payee. If a participant or their attorney provides you with a copy of a divorce decree that references the plan or a QDRO, please contact us immediately, and we will work with you to ensure it meets the requirements of the plan.
Important note for defined benefit plans: For 2025 plan years, PBGC premiums are due one month earlier than usual, specifically on the 15th day of the ninth month after the beginning of the plan year. For calendar year plans, this means the premium is due on September 15, 2025, instead of the usual October 15. This accelerated deadline is due to a provision in the Bipartisan Budget Act of 2015.
Upcoming Compliance Deadlines for Calendar-Year Plans
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