Safe Harbor 401(k) exempts plans from most annual compliances. In this article, we will explain the plan’s definition and go over the plan requirements. It was first introduced in 1996 with the Small Business Job Protection Act. The purpose of safe harbor 401k is to simplify the non-discrimination policies so that more employers would offer 401k to their employees.
However, the term safe harbor isn’t just something related to 401k. This is a broader term that has its use in real estate and finance. Other than 401k, the most common use of safe harbor is when a business renovated and claims a deduction for these.
Generally, when retailers and restaurants or any other business renovates an area, the IRS allows the expenses to be deducted. This would create quite a bit of a challenge on their federal income tax returns.
Instead of looking for the category of deductions that have a long list, the IRS created a safe harbor accounting method for businesses that are eligible—most specifically, retail and restaurant. This simplified their tax returns and made the deductions a lot simpler.
Safe Harbor 401k Plans Definition
Safe harbor 401k plans are mostly for highly compensated employees. It makes the plan exempt from most annual compliance testings for highly compensated employees.
Who is a high compensated employee?
Any employee that is earning $130,000 or more or own at least 5% of the company is a highly compensated employee. Those who also have a family member who owns at least 5% in the company are also considered as highly compensated employees.
Safe Harbor 401k Match Rules
With safe harbor 401k, there are three ways to match employee contributions. How the employer is going to match employee contributions depend on the way that it is set up. These match rules are as follows.
Basic Safe Harbor Match
With a basic safe harbor match, the employer matches 100 percent of the first 3 percent of the employee contribution. This is done for every employee and the employer matches 50 percent of the next 2 percent The employees must defer money to their 401k in order to get an employer match.
Enhanced Safe Harbor Match
The employer matches 100 percent of the first 4 percent of each employee’s contributions and the employees must contribute to their account to qualify for the match.
Non-Elective Safe Harbor
Employees get up to 3 percent of their annual salary in employer match. What makes a non-elective safe harbor attractive is the account is immediately fully vested and employees get this employer match whether they defer money to their 401k or not.
Safe Harbor 401k Plan Requirements
If a 401k retirement plan includes safe harbor provision, the non-compliance tests will be automatically passed and the employer will contribute to the employees’ 401k accounts annually.
The best part about safe harbor 401k plans is not just that there isn’t a plan requirement but the contributions both on the employee and the employer end are vested immediately. This is regardless of the way that the employer contributes.