Posted on Feb 13, 2023

Traditional 401(k) and safe harbor 401(k) plans are similar and are available for employers of any size. However, a safe harbor 401(k) plan has certain advantages for business owners who want to maximize their tax-deferred contributions and avoid annual, onerous IRS nondiscrimination testing. Employees also benefit because they are fully vested when employer contributions are made, no matter how long they’ve been with the company.

With a traditional 401(k), employers must comply with nondiscrimination rules intended to ensure that the plan doesn’t favor owners and highly compensated employees, but benefits all workers equally. Nondiscrimination testing in a traditional 401(k) plan involves:

  • ADP (Actual Deferral Percentage): This test compares the salary deferrals of highly-compensated employees (HCEs) to the salary deferrals of non-highly-compensated employees (NHCEs) to ensure there isn’t a large discrepancy between what HCEs deposit in their plans compared to NHCEs.
  • ACP (Actual Contribution Percentage): This test is similar to the ADP test, but it also includes employer-matched contributions and after-tax contributions from employees. The intent is to ensure all employees are receiving fair compensation.
  • Top-Heavy Test: This test measures the plan’s balance, and if the value of the assets in key employees’ accounts exceeds 60 percent of all assets from the benefit plan, it will fail this test.

The safe harbor 401(k) plan is not subject to annual nondiscrimination testing but employers must make mandatory contributions to employee 401(k) accounts, and the funds become vested immediately. There are different types of safe harbor plans, and employers may choose to make matching contributions, contributions to all employees whether they participate in the plan or not, or contributions that meet or exceed what is offered in a basic plan. Employers must also provide notice to employees describing the safe harbor method in use, how eligible employees make elections, and any other plan involved. 

Watch this video for more information on how safe harbor plans can benefit you and your business:

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