What Is a Safe Harbor 401(k)?

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on February 15, 2024

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Safe harbor 401(k)s are retirement plans, that are variants of traditional 401(k)s, designed to pass the IRS’s nondiscrimination test.

The test ensures that employers make equal percentage salary contributions to all employees and avoid discriminating against employees with low salaries.

Depending on percentage of the employer’s matching contribution, Safe harbor 401(k)s come in four flavors: nonelective, basic safe harbor, QACA, and enhanced safe harbor.

The advantages of Safe harbor 401(k)s are that they allow flexibility in maximum contribution limits, provide tax benefits and help employers avoid noncompliance tests.

The disadvantage of Safe harbor 401(k)s is that they may end up costing employers much more than a traditional 401(k).

They are also administratively more complex as compared to traditional 401(k) and require a careful assessment before they are implemented.

Have questions about Safe Harbor 401(k)s? Click here.

Basics of Safe Harbor 401(k)

In a traditional 401(k), employers must perform annual tests known as Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP).

The ADP ensures that deferred salaries for all employees are equal to the same percentage of their annual compensation while the ACP ensures that the employer’s contribution match, in terms of salary percentage, is equal to that of the employee.

The nondiscrimination tests can end up adversely affecting retirement savings for senior executives and highly-compensated employees or employees who earn more than $155,000 annually, as of 2024.

This is because they set artificial limits on the percentage of their compensation that such employees can contribute to their plan.

The general rule is that highly compensated employees cannot contribute more than 2% more than average of all employees.

Therefore, if the remaining employees of a firm make an average investment equal to 3% of their annual salaries, highly compensated employees cannot contribute more than 5% of their salary to their 401(k) by law.

The maximum deferral limit in Defined Contribution Plans is $23,000. By implementing a Safe harbor 401(k), businesses can help highly compensated employees reach the maximum deferral limits.

Safe harbor 401(k)s allow for immediate vesting of contributions, meaning ownership of contribution is immediately transferred to employees without vesting periods.

There are four ways to set up a Safe Harbor match:

  • In a nonelective Safe Harbor 401(k), employers contribute 3% of matching contributions and it is immediately vested. Employee contribution is not necessary.
  • In a Basic Safe Harbor 401(k), employers can contribute 100% of the first 3% of each employee’s contribution and 50% of the next 2%. Employee contribution is necessary.
  • In an Enhanced Safe Harbor 401(k), employers match 100% of the first 4% of each employee’s contribution. Employee contribution is necessary.
  • In a Qualified Automatic Contribution Arrangement (QACA), employers can either match 100% of an employee’s contribution up to 1% of his or her contribution and make a 50% matching contribution for the next 5% or they can make a 3% nonelective contribution to all participants of the 401(k).

How to Set Up a Safe Harbor 401(k)

Because they are similar in scope and structure to 401(k)s, Safe Harbor 401(k)s have a similar application process.

The deadline to start a Safe Harbor plan is October 1. Existing 401(k)s can also be converted to Safe Harbor 401(k)s.

The deadline to convert an existing plan to a Safe Harbor one is Jan 1. Thus, businesses should have a plan to convert existing 401(k)s into their safe harbor equivalent by November 15.

One of the most important steps in setting up a Safe Harbor 401(k) is employee notification.

Employers are required to provide notification of rights and obligations to employees at least 30 days prior (and no more than 90 days earlier) to the plan’s commencement.

Safe Harbor 401(k)s require research and assessments before they are setup.

Generally, firms with a low headcount and a significant number of highly compensated employees opt for such plans because they enable employees to squire away funds above and beyond the requirements in traditional 401(k)s.

The selection of a Safe Harbor 401(k) depends on several factors, such as the total number of employees participating in the plan and their respective percentages of salary deferral.

Using an excel sheet, businesses can calculate the payout costs based on employee contributions and decide on the appropriate safe harbor plan.

For example, businesses with a greater percentage of highly compensated employees might find QACA or an enhanced safe harbor plan a better fit for their organization.

Advantages and Disadvantages of Safe Harbor 401(k)s

The advantages of Safe Harbor 401(k)s are as follows:

  • They can help businesses circumvent expensive and time-consuming annually mandated nondiscrimination tests.
  • They provide tax benefits similar to those of traditional 401(k), meaning they decrease the amount of taxable income.
  • They help attract and retain talented highly-compensated employees by ensuring that they are able to save more of their salary for retirement.
  • They can be combined with profit-sharing to further increase contribution limits.

The disadvantages of Safe Harbor 401(k)s are as follows:

  • They can be administratively complex because they require careful analysis and calculation of possible retirement planning outlays for a business.
  • They can be expensive because employer contributions, once decided, are fixed. That is, employers must make these contributions to employees during every pay period or else face legal consequences.

    In some instances, where the contributions are high, Safe Harbor 401(k)s are more expensive as compared to traditional 401(k)s.
  • They are accompanied by an immediate vesting requirement, meaning employees, even those who have resigned or are leaving in a short period of time, are entitled to these contributions.

Safe Harbor 401(k) FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.

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