Important Deadlines

It is vital for small businesses to be aware of the following Safe Harbor 401(k) deadlines:

• October 1, 2024: The latest start date for a newly-established Safe Harbor plan for 2024
• December 1, 2024: The last date to notify employees about adding a Safe Harbor matching contribution to an existing 401(k) plan for 2025; and the deadline to elect the 3% non-elective contribution for an existing plan for 2024

Meeting these deadlines allows businesses to maximize the benefits of a Safe Harbor 401(k) plan, both for the company and its employees, while ensuring compliance.

The Safe Harbor Run Down

A safe harbor 401(k) plan is a strategic option for small businesses. Annual IRS nondiscrimination tests are designed to ensure fairness in how plans run, so that they don’t favor top level employees over the rest. Many small plans will fail these tests, and Safe Harbor gives them a way around it. By incorporating certain features, Safe Harbor 401(k) plans can circumvent annual testing.

What’s the trade-off? Employers will need to make contributions to employees’ accounts. These are done in one of two ways: either a matching contribution or a non-elective one. Matching contributions tend to be more popular, but both types have benefits. Here’s one example of how a matching contribution might be structured.

100% of the employee’s contribution up to 3% of their pay, then
50% of the next 2% of their pay, resulting in a 4% match for employees who contribute 5% of their pay.

Non-elective formulas are so-called because employees receive the contribution whether they elect to contribute to their own account or not. These are often an annual contribution of 3% of employees’ pay.

Another significant benefit of Safe Harbor 401(k) plans is that they require immediate vesting (except for a QACA Safe Harbor plan that will allow up to a two-year cliff). This means that the employer’s contributions belong to the employee from day one, providing them with a sense of security and immediate ownership over their retirement savings. This feature not only promotes employee satisfaction but also helps in retaining talent by offering them tangible, immediately accessible benefits.

Consider Time for Setup

Safe Harbor plans must begin by October 1, but smart business owners start earlier and consider the time required for setup and onboarding. Many retirement plan providers need weeks to complete setup, so although the IRS start date deadline is Oct. 1, the provider deadline might be a month earlier — or more.

Since 401GO has a 15-minute automated setup process, businesses can start their plan setup as late as September 30. As long as their documents are signed on that date, the plan can begin the following day and remain within the guidelines.

Obviously, we hope you won’t need to cut it that close, but if you do, we’ll be here. Give us a call to get your questions answered today.

The post Why It’s Important to Think About a Safe Harbor 401(k) Plan Now appeared first on Fast and Affordable 401k for growing businesses.

Here in Utah, the first week in October is usually when fall leaves are at their most colorful. Students are already bored with their new classes. The days average a comfortable 70 degrees while nights get chilly and sweaters are required. That feels a long way off from a mid-July day like today, with kids at play, sunflowers in full bloom and the mercury threatening to break 100 well into the foreseeable future.

So why are all the other 401(k) providers getting all worked up on social media, saying it’s urgent that the process of creating a new safe harbor plan must begin immediately if that distant deadline is to be met? Is it possible their calendars are broken?

One post in particular actually features video of a plan consultant on a sweltering golf course warning, “We need signed paperwork by August 30th. A lot of the record keepers actually need signed paperwork by mid-August…in order to be a safe harbor plan. I know a lot of people have been enjoying their summer, but deadlines are coming up!”

How fast can 401GO set up a safe harbor 401(k) plan?

It’s all a bit foreign to us at 401GO because our technology and automation can get a safe harbor 401(k) set up in about 15 minutes. That means we’d be safe if we started posting gentle deadline reminders around noon on September 30th.

The difference is, the others use the outdated legacy technologies that actually do require weeks and sometimes months to accomplish what we can in less time than it takes to mow your back yard.

So do enjoy your summer, take your vacation and come see us when the kids are back in school. That’ll be more than enough time to get your safe harbor 401(k) plan set up, with all the many benefits that entails, including significant tax advantages and reduced administrative burden.

If you would rather get that conversation started today, we’re up for that, too.

The post Enjoy Your Summer: 401GO Can Set Up Your Safe Harbor 401(k) in Minutes appeared first on Fast and Affordable 401k for growing businesses.

What Is a Safe Harbor Plan?

As the name suggests, a safe harbor is a place where you can feel secure. In life, you may consider your home or your family a safe harbor. Businesses that have “safe harbor” in their name often include mental health services, legal services, hospice care and yes, even maritime services in literal harbors. But in legal terms, a safe harbor refers to being protected from legal actions when you meet certain qualifications.

The IRS has a safe harbor plan that offers a kind of amnesty to workers who have not paid all the taxes they owe, and another safe harbor plan allowing landlords to deduct expenses related to their tenanted property. The one that we’re talking about today is a Safe Harbor plan for 401(k)s. This type of 401(k) allows employers to sponsor and operate their plan without having to submit to the same types of government audits that other businesses must submit to. How do they get this sweet deal? Basically, they pay for it.

Who Needs a 401(k) Plan Audit?

The government mandates that businesses that have 100 or more participants in their 401(k) plan conduct yearly audits. Although mandated by the Department of Labor and the IRS, these audits must be commissioned by the businesses themselves and completed by an independent, qualified third party (not your financial advisor). However, there are many exceptions to these audit rules, such with businesses that have regularly fluctuating numbers of employees, like accounting firms during tax time. The IRS has a helpful document about filing requirements, and you may not be surprised to find out it includes a disclaimer that says the list of requirements and exceptions is not exhaustive.

The cost of a 401(k) audit can range from a few thousand dollars to tens of thousands of dollars, making the administration of a 401(k) plan much more expensive — perhaps prohibitively so to small businesses.

While many of us may enjoy thinking of the IRS as capriciously nefarious, these audits exist to prevent some unscrupulous small businesses from hoarding all the benefits of a 401(k) for their owners and highly compensated employees. Additionally, audits identify situations in which businesses may not be in compliance with ERISA laws, as well as look for possible financial reporting errors. If problems are found, businesses are often allowed to address them to bring them back into compliance before being slapped with a fine. However, corrective action can be expensive as well and take months to complete.

Safe Harbor: A Get-Out-of-Audit Free Card

To a small business, this type of oversight can sound taxing. For this reason, many turn to a Safe Harbor 401(k) plan, which does not require regular audits. Why is this allowed? Because small-business owners who start a Safe Harbor 401(k) are required to contribute to the accounts of participating employees, rather than using their 401(k) plan as a vehicle to stash tens of thousands of dollars away for themselves while offering nothing to employees. This is known in the industry as operating a “top-heavy” plan, which is prohibited with traditional 401(k)s.

Employers with a Safe Harbor 401(k) must match employee contributions 100% up to 3% (or 50% up to 6%, etc.). Depending on the number of employees you have, this can be a significant expense — one that you hadn’t counted on, if you were considering offering a 401(k) with no employer match.

To the uninitiated, a 401(k) without an employer match may look no more attractive than a personal IRA — and you don’t have to wait around for vesting. But the max individual contribution to an IRA is $6,500, while the max individual contribution to a 401(k) is $22,500. So a 401(k) with no employer match is better than an IRA, but not better than quitting and taking a job with a company that offers an employer match.

Additionally, when you sponsor a Safe Harbor 401(k) plan, you must offer your employees immediate vesting. No holding their retirement savings hostage while they toil away for years in a state of feigned loyalty.

The government believes these “drawbacks” are worth the tremendous benefit of being able to skip out on yearly audits.

Is a Safe Harbor Plan Right for You?

Small-business owners must ask themselves a number of questions to help determine whether a Safe Harbor plan would be a good choice for them.

1.       How much is the plan likely to cost me in employer contributions to employee 401(k) accounts?

2.       Is this significantly more or less than the expected cost of an audit (if employer contributions are an uncertain factor)?

3.       Is my company’s size likely to change much over the next few years?

4.       Relative to vesting, do I have high, medium or low turnover?

5.       What are my overall goals for a retirement plan for my company and myself?

Your accountant or financial advisor may be able to help with some of these answers. When you decide whether you want a traditional or Safe Harbor 401(k) plan at your small business, 401GO is the place to get it. You can set your plan up in minutes, rather than weeks or days, and it will practically run itself with our 360-degree integration with payroll systems. Set a goal today to learn more, come to a decision and start your company’s 401(k) plan.

The post Safe Harbor or Traditional 401(k): Which Is Better for Your Small Business? appeared first on Fast and Affordable 401k for growing businesses.

What Is a Safe Harbor 401(k) Plan?

This may not surprise you, but the IRS has a long list of complicated rules that apply to businesses operating 401(k) programs, and the testing that ensures compliance doesn’t come cheap. Sometimes these regulations are so onerous that they act as a deterrent for businesses interested in starting a 401(k) plan. Small businesses are often treated the same as large companies, but with an unfair disadvantage of fewer employees to balance out a plan. However, in the case of 401(k) plans, small businesses have an alternative: Safe Harbor plans.

A Safe Harbor plan has different rules and affords participating companies certain exemptions that can make this type of plan easier to manage for a small business.

How Is a Safe Harbor Plan Different from a Traditional 401(k)?

When 401(k) plans began replacing pension plans in the 1980s, the burden of funding retirement was shifted from the employer to the employee. While employers still have the role of managing the 401(k) plan, they no longer have to worry about funding a pension plan that hundreds or thousands of employees were counting on in their retirement. Instead, employees now bear the risk of market corrections, inflation and other issues that can impact the purchasing power of their retirement savings.

As a way to help protect employees — especially those at the bottom of the workplace hierarchy — the IRS instituted rules that businesses must follow in order to limit an employer’s ability to funnel most of the benefits to highly compensated employees. In order to ensure these rules are being followed, employers offering a traditional 401(k) plan must conduct yearly nondiscrimination tests. If a business fails this test, it may be required to make restitution, such as contributing more to affected low-level employees’ accounts.

But even those businesses that pass the test must set aside funds to pay for it, and these costs can be prohibitively expensive to small businesses. That’s why Safe Harbor plans are so attractive to small businesses — they are exempt from nondiscrimination tests.

Why Choose a Safe Harbor Plan?

So why wouldn’t every business set up a Safe Harbor plan, you ask? There are many reasons, but one of the main ones is that with a Safe Harbor 401(k) plan, employees are required to be vested right away, rather than over a period of years. Many businesses rely on their vesting schedule to discourage employees from hopping among competitors in the same field, quickly jumping ship for a slightly higher salary or more flexible work schedule. If an employee is close to being vested, they are more likely to stick with a company even when a competitor offers them an attractive package. When you choose a Safe Harbor plan, you have to be comfortable with the employee owning your contributions from the moment you make them.

Additionally, a Safe Harbor plan may end up costing some business owners more than a traditional 401(k). This can happen in the case of employers who want to offer their employees a 401(k) plan, but can’t afford (or don’t want) to make matching contributions on their behalf. If you choose a Safe Harbor plan, you will save by not having to conduct expensive tests, but you will be required to make some contributions on behalf of your employees. You may pay less with a traditional 401(k) that doesn’t require you to make employer contributions.

Safe Harbor plans are essentially broken down into four types:

• Non-elective: With a non-elective plan, employers contribute 3% to all eligible employees’ 401(k) plans, regardless of whether the employee contributes anything themselves.
• Basic: With this plan, employers must only contribute to the accounts of employees who elect to also contribute themselves. Employers must provide a 100% match for employee contributions up to 3% and 50% for the next 2%.
• Enhanced: With an enhanced Safe Harbor plan, the 100% match increases to 4% and can be applied through 6%.
• QACA: With QACA Safe Harbor plan, the first 1% of income an employee contributes is matched at 100%, and the next 5% is matched at 50%. This type of plan requires automatic enrollment, but allows employees to opt out.

The type of Safe Harbor plan you choose for your company will depend on your finances and your preferences for human resource management strategies.

Is a Safe Harbor Plan Right for Your Company?

Safe Harbor plans are a way for small-business owners and all highly compensated employees at the company to be able to contribute to their retirement funds without the worry of passing nondiscrimination testing, but it’s not the only way. If you believe that a Safe Harbor plan would be too expensive for your company, one option is to make 3% employee contributions to traditional 401(k) plans automatic. Although employees have the ability to opt out of this arrangement, doing so is an extra step many will not bother to take. And the more employees you have in the plan, the greater the chance you will pass nondiscrimination testing, because the benefits are spread around more evenly.

It’s not guaranteed, however, and it’s important to weigh all your options and consult with your financial advisor before making a decision about going with a traditional 401(k) or a Safe Harbor plan. Once you’re ready to embark on a retirement saving program at your small business, it’s quick and easy with 401GO.

The post Why Safe Harbor 401(k) Plans Are so Popular with Small Businesses appeared first on Fast and Affordable 401k for growing businesses.

But they’re not right for every business, so make sure you understand the pros and cons before jumping into this type of retirement plan.

What are Non-Elective Contributions? 

Non-elective contributions are funds employers pay directly to workers’ retirement plans, regardless of whether employees make their own contributions. These contributions come directly from the employer, and are not deducted from employees’ salaries.

This distinction separates a non-elective contribution from a matching contribution plan where an employer contributes depending on the amount of money deducted from an employee’s salary.

Employees love non-elective contributions because they are paid above their regular wages, essentially giving them extra compensation without extra work. And, when invested, these funds can provide a substantial boost to their retirement savings, helping them achieve more than they could do on their own.

Employers love them too. Non-elective plans give businesses the flexibility to change contribution rates as needed. However, non-elective contributions can not exceed the annual contribution limits the Internal Revenue Service (IRS) set ($58,000 annually in 2022).

And, they provide advantages that can help businesses plan for and moderate their tax burdens. 

Advantages of Non-elective Contributions to Small Businesses

Non-elective contributions are tax deductible and can encourage more employees to participate in the company’s retirement plan.

The decision to offer fully-vested non-elective contributions can also provide retirement plans with Safe Harbor protection, which exempts plans from government-mandated nondiscrimination testing, refunds, and penalties. The IRS administers these tests to ensure plans are designed to benefit all employees instead of favoring highly-compensated ones. Making non-elective contributions can help employers meet this goal while remaining compliant with government rules. 

To be granted safe harbor by the IRS, employers’ non-elective contributions must be at least 3% of employees’ pay. For example, an employer may decide to contribute 10% of the employee’s salary towards the retirement plan. This means that, for every one dollar of salary, the employer will contribute 10 cents, regardless of whether the employee makes an elective deferral towards the plan.

Contributions are made at year’s end, giving employers time to determine what they can afford. However, safe harbor non-elective contributions can also be paid with each payroll, equalizing these annual costs. And, using an automated provider like 401GO, these payroll deductions are done automatically, removing the time and hassle burdens from business owners and their admins.

Plan sponsors can select different eligibility rules for the non-elective and matching contributions. For example, a plan could allow immediate eligibility for employees to make their own deferrals, while requiring 1 year of employment before receiving profit-sharing funds. 

Because non-elective contributions don’t count toward the IRS deferral limit, highly compensated employees can maximize their retirement contributions, and the employer will not have to worry about annual compliance testing. Some of the calculation options are weighted for age and salary. This allows business owners to offer attractive compensation plans to their key employees, and gives them added ability to maximize their own retirement accounts.

401GO can help you design a plan with Safe Harbor non-elective contributions that meet your business needs and ensure compliance.

Disadvantages of Non-elective Contributions 

Offering non-elective contributions may not be feasible for all employers, especially those running small businesses. Making non-elective contributions means flowing money into default funds for employees who don’t manually enroll, contribute, or select an individual retirement plan. Employers must take due diligence and be responsible for enrolling and selecting this fund for the employee.

To simplify this process, the Pension Protection Act of 2006 outlined its Qualified Default Investment Alternatives (QDIAs) program and how employers can enroll workers in these funds while maintaining Safe Harbor protection.

However, this should not be viewed as the definitive option that would meet the needs of all employees. Employers should still look at their workforce to determine the appropriate plan needed for them while also remaining compliant with government regulations.

Choosing 401GO as your 401(k) provider can alleviate some of these concerns, as we will provide for the QDIA, send out required annual notices, file reports, and manage the administration of the plan on your behalf.

Tax Benefits Can Save Businesses Thousands 

One of the main benefits of non-elective contributions is that the contributions are tax-deductible for the business, which can provide a significant tax break for the employer. Businesses can provide additional retirement funds in lieu of a raise, without increasing payroll taxes, and many employees prefer this type of compensation, making it a win-win. 

Employers who make a non-elective contribution can often offset the cost of the contributions from the tax breaks they receive. 

Why Employees Love Profit-Sharing

A benefit of non-elective contributions is that this may be the only funds the employee is putting into their retirement account. A shocking 55% of employees do not keep a retirement savings account, which leaves them more vulnerable to retirement emergencies and expenses. 

Employees with tight budgets often appreciate having some retirement savings without needing to defer any of their own pay. By giving such employees non-elective contributions, an employer motivates the employees to contribute to their 401(k) plan more frequently and plan for their retirement.

Is a Non-Elective Plan Right for You? Just Ask.

Profit-sharing plans are not right for every business. They can be expensive for some small companies, so you’ll want to consider all your financial and labor needs before committing. 

401GO makes the process as seamless as possible. We provide profit-sharing calculations, simple automated management, payroll integration and compliance monitoring all at a low per-participant price.

If you’re thinking of offering non-elective contributions to your team, ask us for a quote. We’ll be happy to walk you through the decision.

The post How Do Non-Elective 401(k) Contributions Work? appeared first on Fast and Affordable 401k for growing businesses.

Each 401(k) plan is required to perform annual nondiscrimination tests, and report on the details of the plan operation.

The 4 Primary Noncompliance Tests

Test 1: ADP/ACP (Actual Deferral & Actual Contribution Percentage) Tests

To run this test, employees are divided into two groups: highly-compensated employees (HCEs) and non-highly compensated employees (non-HCEs). The IRS defines an income level that qualifies one to be an HCE, and that amount may change each year. Ownership can also qualify one to be an HCE.

If the actual deferral percentage (ADP) of the HCE group is more than a certain percentage over   that of the ADP for the non-HCE group, the plan will fail the test. The ACP test works the same way, but looks at the employer’s matching contributions.

Employers who fail this test are typically required to refund excess contributions back to the HCEs or make a contribution to employees, which can be costly, embarrassing, and frustrating.

Test 2: Top-Heavy Test

For this test, employees are divided into two different groups: key employees (owners and executives) and non-key employees.

At the end of the plan year, the total dollar balance is evaluated. If more than 60% of the money belongs to key employees, the plan fails this test.

To correct the failure, employers are typically required to make extra contributions to non-key employees up to 3% of their compensation, which can be expensive.

Test 3: Compensation Test

This test looks at how much actual compensation is allowed to be contributed to the retirement plan. Since many compensation plans include commissions, bonuses, tips and so forth, which can be a substantial portion of an employee’s total pay, the rules within the plan about allowing contributions based on these types of pay need to be fair. 

As a rule of thumb, if the average amount of compensation excluded is 3% or more, the plan will fail this test.

Test 4: Coverage Test

This plan looks at employees who are excluded from participation in the plan. Currently, employers cannot exclude employees based on their work status (full-time or part-time) but they can exclude based on job title. For example, interns or temporary workers are often excluded.

If a large number of employees who would otherwise be eligible are excluded, the plan will fail this test. This test requires that at least 70% of eligible employees are participating. (Ineligible employees are not included in the test.)

Failing this test usually requires the employer to make amendments to the plan document to adjust which employees can be included. This can be quite time-consuming and potentially costly.

Two Helps for Testing Issues

Small businesses often run into problems with these tests. When employee head count is low, even a few highly-compensated or key employees can throw the balance off easily. To help small businesses avoid costly problems, we offer these two solutions.

Solution 1: Automated Testing

Most businesses hire a third-party administrator (TPA) to do this testing once a year. Because 401GO tests are performed by technology rather than an auditor, it can run continuously and watch for problems throughout the year. 

If problems are found early, the employer has time to correct them while they are still small. They could potentially avoid costly rectification at the end of the year by keeping a watchful eye all year long.

Solution 2: Safe Harbor Plan Design

We often recommend safe harbor plans for small businesses. They exempt businesses with some of the required testing, saving them time, money and headaches. If our automated system determines that your plan is likely to run into problems, it will recommend a safe harbor plan, although you are not required to use it.

Tax Reporting

All 401(k) plans are required to file a form 5500 each year. This is a tax reporting document that gives the IRS information about benefit plans, and helps ensure the operations and finances of these plans are being managed properly.

This includes details such as:

• Number of eligible employees
• Number of employees participating 
• Amount of employer contributions
• Earnings and losses
• Rollovers into the plan
• Distributions out of the plan
• Insurance information
• Service provider information

This document is quite involved and if the filing requirements aren’t met, the employer could receive hefty fines or penalties. The IRS may charge $250 per day, and ERISA may charge $2259 per day for late filing.

Other forms may also be required. 

One Help for Report Requirements

Because the document is quite involved and complicated, most businesses feel compelled to hire a qualified benefits specialist to complete the preparation on their behalf. Most of these specialists will want the plan sponsor to sign the document, verifying its accuracy before filing. 

This can be a real problem for plan sponsors who aren’t ERISA specialists and who may not fully understand what is being reported. Although the plan sponsor has ultimate responsibility for the plan, they may rightly feel uneasy about the contents of the form.

At 401GO, our technology completes this form 5500 on your behalf. If any red flags are identified, we work to address them quickly. And further, we will sign and file the form on your behalf. You can feel safe knowing that we will take responsibility for the contents of the form, and that our automation will ensure it is completed and filed on time.

Consequences of Test Failure

For small businesses, 401(k) test failure is surprisingly common, with over a quarter of non-safe-harbor plans failing the ADP test, and a whopping 45% failing the top heavy test. Failing a test probably won’t be devastating, but correcting failures properly can be difficult and costly.

It’s crucial for small companies to choose a plan design up front that supports their individual circumstances. And, if a failure should happen, communicate with the 401(k) provider about performing plan testing and keep a watchful eye on test correction dates.

To limit your risk of test failure, use 401GO as your retirement plan provider. Our plan design suggestions and automated ongoing testing can save your business time, money and hassles.

The post 401(k) Compliance: What You Need to Know appeared first on Fast and Affordable 401k for growing businesses.

Key Considerations When Selecting a 401(k) Plan for Small Business Employees

Recent legislation coupled with cutting-edge technology has expanded available online 401(k) plan options for small business owners. However, it’s important to know that not every digital retirement savings platform is created alike. With so many available products to choose from, finding the right plan can feel overwhelming. Knowing some of the most critical factors to look for when comparing potential 401(k) benefits programs can help you make an informed final decision.

Some key considerations when finding the right 401(k) plan for your small business should include:

• Affordability
  As with any professional investment, the cost will play a significant role in the decision-making process. Some online 401(k) plans claimed to be designed for small businesses — however, many don’t appear to be priced for small businesses. A program that offers a flat rate per plan participant and no hidden fees is a great way to keep a steady focus on the overall return on investment.
• Payroll Integration
  Most small business leaders don’t have the time or resources to process payroll on its own; adding a 401(k) plan can mean extra time and energy spent transferring data from their payroll tool into an added retirement savings plan. When sourcing 401(k) savings plans, look for a provider that offers seamless payroll integration with your existing platform. An automated digital option eliminates manual entry and reduces the risk of data entry error from payroll to plan.
• Safe Harbor Plans
  A Safe Harbor plan allows employers much more flexibility in contributing themselves, and also providing them with an exemption from nondiscrimination testing. Matching employee contributions not only reduces your business taxes at the end of the year, but accentuates the retirement benefit for everyone enrolled. Partnering with a provider with experience setting up Safe Harbor plans can help keep your business compliant with current rules and regulations.
• Easy Signup
  A fast, straightforward setup process is a must for small business owners who are typically tasked with multiple roles and responsibilities. Even organizations with a designated HR department can benefit from using a product that accelerates matriculation. Look for a full-service provider that can automate as much of the process and puts the control in employees’ hands.
• Personalized User Experience
  When choosing an online 401(k) plan for your small business, it’s easy to get caught up in the technology. Yes, innovation is essential for automation and integration. However, saving for retirement is a personal process that doesn’t offer a one-size-fits-all solution. A leading provider of 401(k) savings plans will not only offer the tools; they will provide a personalized user experience with easy-to-access staff members who are available to troubleshoot and answer questions to lower the stress associated with retirement savings.
• Seamless Tech & Touch
  Technology is important but optimal outcomes are the result of engaged, human advisors working in conjunction with the innovation and automation of the system. Look for a provider that adjusts their advisory input based on your specific needs. The right provider will be able to encourage and support collaborating with outside advisors if your business already has one, set your business up with an advisor if you’d like, or provide limited input as needed if you feel like your employees are able to manage on their own.

Make 401(k) Savings Easy, Fun, and Personal

401GO simplifies the 401(k) retirement savings process for business owners, HR professionals, and employees.

The post Find The Right 401(k) Plan for Your Small Business appeared first on Fast and Affordable 401k for growing businesses.

Let’s first look at one thing that is actually a pretty big deal when it comes to offering a 401(k) Plan. That’s the nondiscrimination testing and how it affects you and your retirement benefit.

Nondiscrimination Testing & Its Importance

Quite simply, every year, every 401(k) plan must go through nondiscrimination testing. There are multiple tests within this that we don’t necessarily need to unpack, but two of these tests, in particular, are important to know.

The two prominent nondiscrimination tests are the following:

I’ll only provide a short summary here for these tests to give you perspective.

ADP/ACP – Average Employee Deferrals/Employer Contributions

The ADP/ACP looks at all those highly compensated employees (anyone that earned over $125,000 in 2019 would be considered highly compensated) and/or has over 5% ownership in the company. This test then compares the average contribution by these highly paid individuals to those that don’t fit that criteria (we’ll refer to those as “staff employees”). This test happens every year. If the participation from the highly compensated employees exceeds a certain percentage of those staff employees, we’ll say by 2%, this test will fail.

• E.g. If the average of the highly paid employees and/or owners is 8%, while those staff employees is 4%, the plan would fail this test. The 2% threshold would mean the highly paid and ownership group couldn’t exceed 6% for their average.

The result? There would need to be a refund of some (perhaps all) contributions made by those highly compensated employees (this includes owners regardless of pay). OR you can make an employer contribution to all employees that are not highly compensated. It isn’t exactly this cut-and-dry, but I think you should know that possible refund or mandatory contribution is required if this test is failed.

Top Heavy Testing

The Top Heavy test looks at those “key” employees, which are your executives and owners. If at the end of the year the total 401(k) plan balance (everyone) has over 60% from these key employees (executives, owners, etc.), then the plan fails the Top Heavy test and would have to make a contribution up to 3% to all non-key employees (this could even include some of those highly compensated employees) in any year afterward that those key employees make contributions.

More info can be found in this article HERE.

• E.g. If the total 401(k) plan assets are $200,000, and $122,000 (61%) of those total assets are key employee assets, then it is a Top Heavy failure.

Now that we have the confusing testing portion out of the way, let’s look at the Safe Harbor option and why they are great for a small business.

A Safe Harbor 401(k) Plan is one in which you, as the employer, agree to using a certain formula to match or provide contributions to your employees that participate in the plan. The biggest perk to having this Safe Harbor provision is that it gives you an exemption from the tests previously mentioned. Yes, that’s right, EXEMPTION. So, if you fail any or both of those tests, you’re exempt from the results if you are Safe Harbor.

Safe Harbor Choices

What are your options for Safe Harbor? Here are the different Safe Harbor options by name:

Let’s go through each one of these so you can understand how they work and more fully know the options and costs.

Basic Safe Harbor

This is the lowest cost Safe Harbor if you don’t add an auto-enrollment. Essentially, you only match what is deferred into the 401(k) plan by employees participating.

Formula – Match 100% up to 3% of employee deferred pay and 50% after up to 5%. Total expense is 4% if an employee puts in 5% or more.

• E.g. – An employee is paid $1,000 on a pay check and wants to put in 5% of pay. This is a total of $50. As an employer using this Safe Harbor you would match 4% (max), and it would be $40 in this example.

Any employer matching contribution is 100% vested. That means, once it goes into the employee’s 401(k) account, it is theirs.

Enhanced Safe Harbor

This is considered a very rich employer match for your employees.

Formula – Match 100% up to 4% OR 5% OR 6% of employee deferred pay. You would have to pick one of these formulas, you couldn’t switch between them.

• E.g. If you selected Enhanced Safe Harbor 4%, an employee paid $1,000 and wanting to contribute 4% of pay, which is $40, would receive a match of $40. Again, 4% is the maximum employer match.

Any employer matching contribution is 100% vested.

Qualified Automatic Contribution Arrangement (QACA)

This is typically referred to as a “Safe Harbor Auto-Enrollment.” That is because it combines the component of auto-enrollment (if your employees don’t “opt-out” from being enrolled into the plan, then they will be automatically enrolled).

Formula – Match 100% up to 1% and 50% after up to 6%. Total expense to the employer is 3.5% if the employee puts in 6%. (Please note, although the total expense is lower and the employee has to defer more of their pay in order to receive more match, the auto-enrollment part of this shouldn’t be overlooked. It will pull more employees into the 401(k) plan through inertia.)

• E.g. If you selected a QACA Plan, an employee paid $1,000 and wanting to contribute 6% of pay, which is $60, would receive a match of 3.5% or $35. The maximum is 3.5% employer match. So, even if an employee put in 20% of pay, the employer would only be putting in 3.5%.

You can choose between a few vesting options. You could select a 2-year cliff (1 year – 0%; 2 year 100%), a 50-50 split (1 year – 50%; 2 year – 100%) or 100% vested immediately.

Safe Harbor Non-Elective

This is a Safe Harbor profit-sharing. It can be up to 6% of employee pay, but is typically at 3% of annual pay. You would have to make that decision annually, and cannot reduce 6% down to 3%, for example.

Formula – Employer non-elective (not related to employee deferral contributions) is 3% of eligible employee’s gross pay (required annually). Eligible pay is $285,000 in 2020 (so if someone has over that amount it would cap there and would be 3% of the $285,000).

• E.g. If you have 5 eligible employees and their gross pay $300,000, then your required Safe Harbor Non-Elective contribution would be $9,000 (3% of pay respectively).

This is 100% vested.

Now, why would you choose Safe Harbor if you have to provide for an employer contribution and follow a specific set formula? The two main reasons are the exemption from the nondiscrimination testing and the reduction in business taxes from that employer contribution. Employer contributions into a 401(k) plan go in pre-tax. So, figure your total tax liability and consider your pre-tax contributions.

It’s always recommended to talk with a tax professional for more details on the tax benefits, but in general, if you could give a benefit to your employees instead of paying that amount in taxes, would you do it?

At 401GO we have many different plan design options, including all the Safe Harbor plans mentioned in this article. Plus you can get set up in under 15 minutes. It’s easy to use, and handles all aspects of the required annual administration. Talk to us today to more fully understand these options.

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