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What companies should consider sponsoring a 401(k) Plan?
According to recently available U.S. Department of Labor, statistics, there are over 560,000 401k retirement plans in the U.S., covering in excess of 100 million participants. 401(k) plan are sponsored by companies from one employee to hundreds of thousands of employees. This makes 401(k) plans the most prominent retirement savings vehicle for employees. A company sponsored 401(k) plan provides an opportunity for employees to contribute a portion of each paycheck to the retirement plan on either a pre-tax or Roth basis. Additionally, employers can choose to supplement the employee savings through matching and/or profit sharing contributions.
Are there IRS rules and requirements that 401(k) Plans must meet?
The Internal Revenue Code and associated Regulations, impose discrimination testing on 401(k) plans. These rules are designed to ensure the 401(k) plan does not discriminate in favor of Highly Compensated Employees (HCEs) over Non Highly Compensated Employees (NHCEs). HCEs are defined as those employees who are either 1) a 5% or more owner during the current or prior year, or 2) whose compensation exceeded the IRS threshold amount in the prior year ($130,000 for 2020). Once the HCE and NHCE group is identified, the IRS testing required may in many plan cases reduce the ability for HCEs who wish to maximize employee deferrals, to defer the calendar year statutory limit ($19500 for 2021), as well as the additional catch-up amount which is available to those who have attained age 50 ($6,500 for 20201).
How can a Safe Harbor 401(k) Plan manage the IRS testing requirements?
Safe Harbor 401(k) plans solve the potential testing imposed cutback result while at the same time providing a meaningful retirement contribution for employees. Safe Harbor 401(k) plans provide an automatic pass to the IRS testing requirement for employee deferrals and thus allow HCEs who wish to maximize their elections, to do so without any further analysis needed. There are two types of Safe Harbor 401(k) Plans:
- Safe Harbor Match 401(k) – the employer must match the employee’s deferral at a rate that is no less than 100% of the first 3% of compensation deferred, plus 50% of the next 2% of compensation deferred. This is the basic formula prescribed by IRS statute. The employer may match at an enhanced rate as long as the formula provides a match that is no less than the basic match at each level of deferral.
2. Safe Harbor Nonelective 401(k) – the employer must make a contribution of at least 3% of the employee’s compensation (or 4% depending on when the plan is amended for safe harbor). The employer’s contribution requirement is not dependent on whether the employee chooses to defer.
Safe Harbor contributions are 100% vested immediately, and thus not subject to a vesting schedule. Once an employee has satisfied the eligibility requirements for a Safe Harbor contribution, there can be no hours of last day requirement imposed to receive the Safe Harbor contribution.
What are the deadlines for adopting a Safe Harbor 401(k) Plan?
On an annual basis, the employer must adopt a Safe Harbor Match 401(k) formula 30 days prior to the beginning of a plan year. In contrast, the Nonelective Safe Harbor 401(k) plan can, if so structured, utilize a “wait and see approach”. Under this approach an employer who adopts the Safe Harbor Nonelective 401(k) formula by 30 days prior to year-end, will be obligated for a 3% Nonelective contribution. Additionally, as a result of the SECURE Act of 2019, an employer can wait and choose to adopt a Safe Harbor Nonelective 401(k) formula from 29 days before year end all the way up to the end of the next plan year. Under this delayed election, the employer’s Safe Harbor contribution obligation would be 4% of compensation for each eligible employee.
Which Safe Harbor 401(k) is right for your company?
An employer’s decision on whether to utilize the Safe Harbor Match or Safe Harbor Nonelective contribution can be a unique decision for each situation. The employer may be looking to reward employees who decide to participate in the plan by making their own deferral. This would lead to a Safe Harbor Match decision. Alternatively, the employer may be looking to layer on a Cross Tested Profit Sharing contribution or possibly a Cash Balance plan on top of the Safe Harbor 401k structure. In that case, the efficiency of leveraging the additional sources on top of the Safe Harbor Nonelective program, would most likely be the most effective structure. Additionally, the timing of an employer’s Safe Harbor 401(k) decision may become a factor on which type of Safe Harbor plan to adopt.
Are you in need of a properly formulated Safe Harbor 401(k) retirement plan? The experts at MGKS have over 30 years of 401(k) retirement planning experience. Scheduling your initial plan proposal consultation today! Learn about the best Safe Harbor 401(k) plan for your business. Sign up now!