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For small business owners, one of the administrative burdens long associated with traditional 401k plans has been compliance with statutory nondiscrimination provisions. Every year, 401k plan sponsors must pass what is known as The Average Deferral Percentage Test ("ADP"), to determine if a business owner's 401 k plan is "top heavy", or inequitably skewed in favor of the owner and/or highly compensated individuals to the detriment of lower paid employees. For many business owners, it was difficult to determine how best to structure their 401k plans commensurate with their goal of maximizing highly paid employee contributions, while at the same time, not running afoul of the ADP provisions. The uncertainty created with respect to retirement planning, in conjunction with the complexity of the ADP test and the varying needs of different closely-held and small businesses, led in 1999, to the creation of the 401k Safe Harbor rules. Now, plan sponsors don’t have to worry about whether contributions in any given year will run afoul of the cumbersome, complex and bedeviling ADP provisions, because as long as business owners adhere to the 401k Safe Harbor rules, they will be deemed to have acted in good faith for purposes of the non-discrimination provisions. The business owner, more likely than not, will have to hire a plan administrator who is familiar with 401k Safe Harbor rules in order to insure compliance, but the tradeoff is well worth it. Because it affords the small business owner certitude with regards to their 401k retirement planning. In short, in exchange for a commitment to make a minimal level of mandatory employer contributions, which many employers make as a matter of course anyway to all eligible employees, ADP testing is eliminated. Here is a synopsis of the 401k safe harbor rules and benefits: - All participants in a 401k safe harbor plan are permitted to make the maximum salary deferral contribution.
- Total contributions for 2010, from both sources (employer and employee), under the 401k Safe Harbor rules, may not exceed 100% of income or $49,000 per eligible plan participant.
- The employer under a 401k safe harbor plan is required to either match employee contributions (100% of the participant's first 3% of salary and 50% of the next 2% of salary) or in the alternative, provide a non-elective contribution (3% of salary for all eligible employees).
Is a 401k Safe Harbor plan appropriate for your business? Many small businesses are suitable candidates for a Safe Harbor 401k plans, including self-employed individuals who anticipate hiring new employees in the near future. As we’ll talk about next businesses that have naturally high salary disparities are great candidates. Some of those businesses are medical and dental practices, consulting firms and law firms. Important factors to consider in making the determination to take advantage of the 401k Safe Harbor rules would be the extent of the salary disparity between highly compensated, key employees and the other employees in the enterprise; the current level of participation by lower-salaried employees in the 401k plan; and, the need for retirement planning certainty for the business owner as well as for other highly compensated employees. These factors should also be evaluated in the context of whether the business has failed to meet the nondiscrimination testing in the past, or if there is a substantial likelihood that it may not pass ADP testing in the future. Employers, who are already providing a generous employer match, may wish to consider the 401k Safe Harbor plan as well. There are additional important requirements for establishing a 401k Safe Harbor plan. All contributions made pursuant to the 401k Safe Harbor rules are immediately vested. Profit sharing and matching contributions that exceed Safe Harbor matching requirements can require a vesting schedule at the election of the business owner. If an employer is concerned that the 100% immediate vesting requirement may negatively impact their ability to retain employees, this consideration should be weighed against the administrative cost of undergoing annual ADP testing and any revisions to the plan that failure to pass the ADP test may entail. The 401k safe harbor plan must be established, or an existing plan amended, before contributions can be made by any participants, including business owners. There are additional mandatory notice requirements to participants that your 401k plan administrator can explain during the establishment phase of your 401k Safe Harbor plan.
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