You may have heard the term “safe harbor 401(k)” floating around, particularly if you’re a small business owner looking for the best retirement options for you and your employees. But, what exactly is a safe harbor 401(k) and does it make sense as a retirement account option?
Yes, it does! Or, at least, it can make sense depending on your business. This type of 401(k) is one of the best retirement plans available today, with various benefits for employers and workers. In this article, we’ll explore what makes safe harbor (401k)s such a valuable investing tool.
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What Is a Safe Harbor 401(k)?
A safe harbor 401(k) is a retirement plan favored by many companies, both large and small. A key advantage this plan offers businesses over traditional 401(k)s is it helps them meet the IRS’ non-discrimination requirement for retirement plans. So, what does that mean exactly?
To promote fairness in employer-based retirement plans, the IRS requires companies to participate in annual nondiscrimination tests. These tests are designed to demonstrate that an employer isn’t favoring certain employees over others regarding retirement plan contributions.
The nondiscrimination assessments are time-consuming and costly to employers, which is why more and more businesses are opting for safe harbor 401(k)s versus traditional 401(k) plans. By choosing to offer safe harbor 401(k)s to their employees, a business is exempt from the IRS nondiscrimination testing requirements.
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What's the Value to Employers and Employees?
Safe harbor 401(k)s offer benefits to both employers and employees. For companies, it exempts them from burdensome annual testing requirements. Additionally, safe harbor 401k(s) are typically more affordable to set up than traditional plans.
For employees, the key advantages of safe harbor 401(k)s are that it guarantees retirement plan contributions and immediate vesting. With traditional 401(k) plans, any contributions your employer makes on your behalf are forfeited if you change jobs before the money vests. Standard vesting schedules under traditional 401k(k) plans are between 1-3 years. However, some plans don't vest until six years of employment at the company.
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What’s the Difference Between a Traditional 401(k) and a Safe Harbor 401(k)?
There are several key differences between traditional 401(k)s and safe harbor 401(k)s to understand, such as:
- With traditional 401(k) plans, employer contributions or matching are not required. Employer contributions are required with safe harbor 401(k)s.
- Employer contributions to safe harbor 401(k)s must be fully vested immediately. Traditional 401(k) plans have the option to vest over a period of years.
- Traditional 401(k) plans are subject to annual nondiscrimination testing; safe harbor 401(k) are exempt from this requirement. This makes them, in essence, a “safer” and easier option for business owners.
Types of Safe Harbor 401(k)s
There are three main types of safe harbor 401(k) plans that offer benefits to businesses and their employees.
- Nonelective safe harbor: Under this plan, employers contribute 3% of a worker’s salary to every employee’s 401(k), regardless of whether the employee contributes any of their own money to the plan.
- Basic or “elective” safe harbor: This plan involves employers matching employee contributions 100% up to 3% and 50% of any additional contributions, up to 5%.
- Enhanced Safe Harbor: Another type of match-based plan, the Enhanced Safe Harbor 401(k), involves employers matching 100% of employee contributions, up to 4%.
All three options have their advantages. However, the plans involving employer matches may offer a greater incentive to employees to contribute towards their retirement.
Final Thoughts
Safe Harbor 401(k)s are an affordable, flexible, and valuable retirement plan option for both employers and employees. Who says there’s no such thing as a win-win in business?
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