Why Should You Have a Safe Harbor 401k Plan?

Why Should You Have a Safe Harbor 401k Plan?

Companies have many things to consider in their day to day operations. For this reason, it can be hard to think about some of the big picture items such as employee retirement plans. But, truthfully, creating an effective retirement plan is one of the most important parts of a business plan.

When it comes to 401k plans specifically, there are some important things to know with regards to legal considerations. For instance, the IRS has a system in place to determine whether 401k plans are fair for all contributing members. In order to ensure fairness, they examine a company’s 401k plan with 3 separate tests. Failing these tests can spell disaster for companies.

Luckily, with the use of a Safe Harbor 401k plan, businesses can rest assured that they will automatically pass the IRS tests of fairness each year.

What Are the IRS 401k Plan Tests? 

At the most basic level, the IRS simply wants to ensure that the higher earners within a company aren’t being significantly favored over lower earners with regard to a company’s 401k plan.

In order to determine whether or not a company’s plan is fair, the IRS runs 3 separate tests each year:

  1. The ACP Test. As the name suggests, the Actual Contribution Percentage Test looks at the percentage of contributions made to the plans of higher wage earners as compared to their lower earning counterparts.
  2. The ADP Test. This test looks specifically at compensation in comparison to how much low and high wage earners defer into their retirement plans. It places a cap on what percentage of salary higher earners can divert into their 401k accounts based on how much lower earners invest in their respective accounts.
  3. The Top Heavy Test. To determine if a test is considered “Top Heavy”, this test looks at the total amount of money in your companies plan, as well as how much of these balances are maintained by the top earners in the company. When these top earners have control of more than 60% of the plan, the 401k plan is top heavy.

As you might imagine, failing these tests comes with significant issues. For one, you’ll likely have to pay some hefty fees. Secondly, you’ll have to fill out tons of paperwork to correct the issue.

The best way to avoid failing one or more of these tests is to implement a Safe Harbor Plan.

What is a Safe Harbor 401k?

A Safe Harbor 401k Plan is one that allows businesses to structure their plan in a way that meets all of the IRS fairness requirements and exempts the business from having to undergo testing.

The plans ensure that business owners match employee contributions fairly through the use of nonelective contributions or other matching methods.

If you’re interested in setting up a Safe Harbor plan for your employees, don’t delay!

You’ll need to start your new Safe Harbor 401k plan by October 1st 2022. Alternatively, you can add a Safe Harbor Provision to your current plan, but you must do so by November 30th, 2022.