As a general rule, 401(k) plans must satisfy certain non-discrimination requirements to ensure the plan does not discriminate in favor of the plan sponsor’s principals. These non-discrimination requirements can limit, sometimes very significantly, the principals’ 401(k) contributions.
Safe harbor 401(k) plans, however, do not need to satisfy these non-discrimination requirements. Therefore, the principals can contribute as much 401(k) contributions as they want since they are not limited by the otherwise applicable non-discrimination testing.
To satisfy the IRS requirements for a safe harbor 401(k) plan, the plan sponsor must:
- (a) adopt a compliant plan document;
- (b) send annual safe harbor notices to all eligible employees; and
- (c) contribute safe-harbor employer contributions to eligible employees.
There are three options:
- Non-elective contribution (provided to all eligible employees) of at least 3% of pay
- Basic matching contribution (provided only to those employees who contribute part of their salary to the plan), structured as follows:
-100% of the first 3% of pay that is contributed, and
-50% of the next 2% of pay that is contributed
-for a maximum matching contribution of 4% of pay
- Enhanced matching contribution
This safe-harbor contribution must be 100% immediately vested.
Many small employers have difficulty satisfying the IRS non-discrimination requirements applicable to 401(k) plans because rank-and-file employees tend to contribute small amounts of pay to the plan if they contribute anything at all.
Those employers are ideal candidates for safe-harbor 401(k) plans.