A 401(k) plan permits employees to contribute (an “elective deferral”) and invest funds under a company-sponsored plan before federal incomes taxes are deducted. Like all qualified retirement plans, 401(k) plans cannot discriminate in favor of highly compensated employees. In order to prove that it is not discriminatory, a 401(k) plan must pass the Actual Deferral Percentage (“ADP”) test with respect to employee deferrals and the Actual Contribution Percentage (“ACP”) test with respect to any employer matching contributions.
A safe harbor 401(k) is a plan that allows maximum deferrals by owners and highly compensated employees (“HCEs”) because of required minimum contributions. It allows for both employer and employee contributions. The benefit of this type of safe harbor 401(k) plan is that by design the plan is considered nondiscriminatory; therefore eliminating the need to perform the ADP and ACP tests on an annual basis. In addition, the employer does not need to make additional contributions or return a portion of the deferrals to HCEs. Corrections would be necessary if a non-safe harbor 401(k) plan fails the test(s). Consequently, any HCEs may contribute the maximum 401(k) contribution limit ($18,000 or $24,000 (for those employees over 50) for calendar year 2015), without considering the amount the nonhighly compensated employee defers. For testing purposes, a highly compensated employee is any employee who earned more than $120,000 (this dollar amount is determined by the IRS each year) in the prior calendar year. Also, the maximum compensation considered is limited to $265,000 for plan years beginning in 2015.
Two Alternative Employer Contribution Options
For this safe harbor plan design, the employer is required to make a minimum contribution which is either (1)a (100% vested, nonelective employer contribution of 3% of pay for all nonhighly compensated employees, or (2) a 100% vested employer matching contribution, but not both.
1. The 3% Non-Elective Employer Contribution
The required non-elective contribution is a 3% employer contribution for each eligible employee, regardless of whether they are employed on the last day of the plan year or have 1,000 hours of service. The 3% non-elective safe harbor option can be satisfied by providing an employer contribution on behalf of all eligible nonhighly compensated participants equal to at least 3% of pay regardless of whether or not they make deferrals into the 401(k) plan.
2. Employer Match Safe Harbor
The safe harbor employer matching contribution, if used, may take several forms. When the basic safe harbor match is used, a plan must provide a matching contribution at a minimum rate of dollar for dollar on the employee deferrals up to 3% of pay and 50¢ per dollar on the next 2% of pay. Thus, an employee must defer at least 5% of pay to get this maximum safe harbor 4% employer matching contribution. When this employer matching safe harbor is used, an employee who opts out of the pre-tax deferral option will not receive an employer safe harbor matching contribution.
For both options, neither the employment on the last day of the plan year nor the 1,000 hours of service test condition can be used as a condition for a safe harbor contribution for any employee who has met the plan’s eligibility tests (which can require a “year of service” in which 1,000 hours of service are required and that a participant be age 21).
Vesting and Other Safe Harbor Requirements
As stated, either safe harbor contribution described in the preceding paragraphs must be 100% vested. It also may not be subject to an hour of service requirement or a last day of the plan year employment requirement. However, the plan (1) can include an age 21 and one “year of service” (at least 1,000 hours of pay in a 12-month period) requirement for an employee to be eligible to participate and to receive the contribution, and (2) may also provide an additional employer profit sharing contribution, which may be subject to a vesting schedule and subject to the 1,000 hour and employment on the last day of the year “accrual” requirements. Finally, the plan may not allow for distributions of the employer’s safe harbor contributions during employment, even for hardship, although employee deferral contributions can be withdrawn for hardship if the plan so provides.
Annual notices for all plans must be given within a reasonable time. Notices given under the guidelines below are presumed to be reasonable. In general, an employer must provide a notice to employees either (1) at least 30-90 days prior to the beginning of each plan year, or (2) at least 30 days before the end of the plan year, if the employees also received a notice before the beginning of the plan year that the employer might utilize a 3% nonelective safe harbor contribution during that plan year.
If an employer with a regular non-safe harbor 401(k) plan wants to wait to decide whether to provide the 3% nonelective contribution, a decision can be made as late as 30 days before the last day of the plan year. If the contribution is not to be made, nothing needs to be done. However if the employer decides to use that option, the plan must be amended to provide for the 3% contribution, and such amendment could be limited for just that plan year in question, leaving open the option for the next year if the requisite notice is given before the next year begins. Notice must be given to employees before the beginning of the plan year in which the 3% safe harbor might be used indicating that the employer might or might not decide to make the nonelective contribution. If the employer later decides to do so, a supplemental notice should be provided (no later than 30 days before the end of the plan year). The plan would be then be amended to allow it, and this amendment could be limited just to that year).
Also, if the employer wants to utilize the safe harbor matching contribution instead of the non-elective contribution, the employees would have to be notified of that decision during the normal notice period (i.e., 30-90 days before the first day of the plan year), but the employer later could decide to discontinue the match during the plan year (with prior notice to employees) and opt to run ADP/ACP testing that year. The discontinuance of the match could not take effect sooner than 30 days after notice of such discontinuance is given to the employees.