Introduction of Safe Harbor
There is a way to create a 401(k) plan and avoid a lot of the yearly compliance testing. It’s called the Safe Harbor Plan. This type of plan automatically complies with the non-discrimination rules previously described. Therefore, the ADP and ACP tests do not apply, and the amounts that HCEs can contribute to the plan are not limited by the contributions of the rest of the workforce.
A safe harbor plan is also exempt from the top heavy test unless an employer makes contributions other than the required safe harbor adjustment described in the next section, or a non-eligible contribution. For example, the top load test may have to be carried out in the case of profit sharing. If the test shows that the plan is top-heavy, the employer may be required to make additional contributions to the plan.
In exchange for being relieved of much of the auditing and other administrative burden, employers who elect Safe Harbor 401(k) must make annual contributions on behalf of their employees and meet other requirements determined by their election to the 401(k) depend on designs.
Safe Harbor 401(k) Design Decisions
A Safe Harbor 401(k) can be designed in two ways – a traditional Safe Harbor 401(k) and a Qualified Automatic Contribution Agreement (QACA). Both avoid the need for testing and oblige the employer to make contributions for the participants. However, some important differences are listed in the table.
Traditional Safe Harbor 401(k) versus Qualified Automatic Contribution Arrangement (QACA)
|Traditional Safe Harbor 401(k)||Qualified Automatic Contribution Scheme (ACA)|
|enrollment||Employees can sign up for the plan themselves, or you can sign up for them. In any case, you must contribute to the plan according to one of the following formulas.||Unless an employee elects not to participate, you must automatically enroll eligible employees in the plan and deduct at least 3% of their salary to be included in the plan.
Thereafter, the employee contribution will automatically increase by at least 1% each year until at least 6% is reached, but the plan may provide for these automatic increases to be as high as 15%.
Additionally, you must contribute to the plan according to one of the formulas below.
The employer pays 100% of the first 3% of salary employees pay into the plan, plus 50% on the next 2% they pay.
The employer pays 100% of the first 1% of salary employees pay into the plan and an additional 50% on the next 5% they pay.
|vesting||The Safe Harbor Contributions – whether Matching or Non-Elective – are always fully vested.||The Safe Harbor Contributions, whether Matching or Non-Elective, must vest in full once the employee completes two years of service.|
Which safe harbor design is right for your business?
When choosing between a traditional Safe Harbor 401(k) and a QACA, consider the following important questions:
- Immediate or Deferred Vesting?
With the traditional Safe Harbor 401(k), employer contributions vest in full when they are paid. However, at the QACA, these contributions may be subject to a two-year vesting schedule. If you leave before the two-year service anniversary, the amount in the employer contribution account will be forfeited. The expired funds can be used in subsequent years to offset the required employer contribution.
- Automatic login or login?
Automatically enrolling employees in a 401(k) has been shown to be an effective way to help employees build retirement savings. Auto-enrollment is optional in the traditional safe harbor design, but required for QACAs.
- Matching or election contribution?
The voluntary contribution option provides a 3% contribution for all eligible employees, including those who do not contribute their own money to the plan. With the Matching Contribution option, contributions are only made for employees who make contributions themselves. Because the basic matching formulas for the traditional Safe Harbor 401(k) and the QACA are different, the potential cost to you will vary based on the number of contributing employees and the rates at which they contribute.
For example, if you choose a traditional Safe Harbor design and all eligible employees contribute 5% or more of their salary, your matching cost is 4% of their payroll. However, in a typical plan, some employees choose to contribute less than 5%, so your cost is typically less than 4%.
Conversely, if you choose the QACA design and all eligible employees contribute 6% or more of their salary, your matching cost is 3.5% of salary.
Safe Harbor 401(k) Deadlines
If you’re considering implementing Safe Harbor 401(k), there are a few important deadlines you need to be aware of:
- new plans — For the first year of the plan, employees must have the opportunity to contribute for at least three months. Therefore, for a 401(k) plan that applies in a calendar year (as most plans do), the plan must be effective no later than October 1.
If you elect to use the QACA design or make matching contributions, employees must be notified at least 30 but no more than 90 days prior to the plan’s effective date. Thereafter, notice of termination must be given between October 1st and December 1st of each year.
- Existing Plans — You can modify an existing standard 401(k) to add a safe harbor feature. The plan can be changed for the calendar year to add this feature by November 30th of that calendar year if you make a voluntary contribution of 3%.
A recent change in the law allows you to wait until the end of the following year if you make a voluntary contribution of 4% instead of 3%. A plan can only be changed at the beginning of the calendar year to add a safe harbor match. In this case, employees must be notified at least 30 days before the start of the year.
Take the next step
JP Morgan’s Everyday 401(k) is designed with you and your employees in mind. If you are interested in setting up a retirement plan for your company and would like to speak to a retirement plan specialist, visit a local Chase office, fill out this intake form, or call 833-JPM-401K.
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