Home

Quick Links

Legal & Sitemap

navigation
Home > Trends & Insights > Should You Consider a Safe Harbor 401(k)?

Article

 

Monday, July 10, 2017

Should You Consider a Safe Harbor 401(k)?


A safe harbor design allows a 401(k) plan to avoid annual nondiscrimination testing of employee elective contributions and employer matching contributions. If you are thinking of implementing a safe harbor 401(k) plan, the following overview may prove useful in your decision making.

The advantages of a safe harbor design
A 401(k) plan generally must undergo actual deferral percentage (ADP) and actual contribution percentage (ACP) testing each year. In addition to allowing a 401(k) plan to avoid the administrative burden of conducting these tests, a safe harbor design may enable highly compensated employees (HCEs) to contribute more to the plan than they could if the plan were subject to nondiscrimination testing. Employers that might benefit most from a safe harbor 401(k) plan include:

  • Firms with highly paid employees who are not able to maximize their plan deferrals because of the low participation rates of lower paid employees
  • Companies already making employer contributions at or near the levels required to meet the safe harbor requirements
  • Employers required by law to make top-heavy minimum contributions

Contribution requirements
Employers that choose a safe harbor plan design must satisfy certain employer contribution requirements. There are two basic options:

  • Make nonelective contributions of at least 3% of compensation on behalf of each non-HCE who is eligible to participate in the plan
  • Match 100% of employee elective contributions up to 3% of compensation, and 50% of elective contributions between 3% and 5% of compensation

Sponsors may also use an enhanced matching formula. With an enhanced match, the aggregate amount of matching contributions at any given deferral rate must at least equal the aggregate amount of matching contributions made under the basic matching formula.

Whether the plan provides for matching or nonelective contributions, they must be fully vested when made.

Required notices
A safe harbor plan must provide written notice of rights and obligations under the plan to eligible employees between 30 and 90 days before the beginning of each plan year. For employees who become eligible after the beginning of the plan year, the notice generally must be provided within the 90-day period ending on the employee’s entry date. Plans that provide for immediate eligibility and permit employees to begin deferrals on the date they become eligible may provide the notice as soon as possible thereafter.

Converting to a safe harbor plan
Both new and existing retirement plans can use the safe harbor design. To convert an existing 401(k) plan, the employer must adopt an amendment converting the plan before the plan year the conversion will take effect. A newly established 401(k) safe harbor plan’s first plan year must be at least three months long (or less if the plan is established soon after the employer comes into existence).

Midyear amendments
Once a 401(k) safe harbor plan is in place, employers have some flexibility to amend their plans during the year. Under IRS Notice 2016-16, a midyear change will not violate the safe harbor rules merely because it is a midyear change, provided it does not violate a list of specifically prohibited changes, and, in the event the change affects the plan’s required safe harbor notice content, applicable notice and election opportunity conditions listed by the notice are satisfied.

Specifically prohibited midyear changes include:

  • Increasing the number of years of service required for vesting in a qualified automatic contribution arrangement (QACA) plan
  • Reducing the number of employees currently eligible to receive safe harbor contributions
  • Changing the type of safe harbor plan (e.g., from a traditional safe harbor to a QACA or vice versa)

Also prohibited is changing the formula for matching contributions if it increases the amount of matching contributions or adds discretionary matching contributions. But, the IRS allows increasing the match if the change is retroactively applied for the entire plan year and it’s based on compensation for the full year. In addition, the change must be adopted and participants must be given notice and an opportunity to change their deferrals at least three months prior to the plan year-end.

If the midyear change affects the required information in the safe harbor notice, the sponsor must then provide an updated safe harbor notice with a description of the midyear amendment and its effective date. Generally, a sponsor has between 30 and 90 days before the change becomes effective to provide notice to participants.

Reducing or eliminating contributions
Generally, for plan years beginning on or after January 1, 2015, a sponsor may reduce or stop making safe harbor matching or nonelective contributions if (1) the employer is operating at an “economic loss” or (2) the safe harbor notice states that the plan may do so and that the reduction or elimination will not apply until at least 30 days after the notice is provided. (Additional requirements apply.) ADP and ACP testing will apply to all elective and matching contributions (including safe harbor matching contributions) made during the plan year.

Documenting hardship distributions
The IRS recently published a memorandum outlining new audit procedures for use by agents verifying whether a plan has followed proper substantiation procedures for safe harbor hardship withdrawals. Plan sponsors may want to review these procedures to anticipate later possible objections to their hardship withdrawal programs.

According to the memorandum, the auditor must determine whether the sponsor — to substantiate the hardship — relied on specific source documents (such as estimates, contracts, bills, etc.) or a “summary” of information on those documents. If source documents were used, the auditor is to determine whether they substantiate the hardship. In the latter case, the auditor is further required to determine whether the summary information obtained from the employee conforms to the requirements set forth in the memorandum attachment.

The attachment lists information that must have been provided to the employee, such as notification that the distribution is taxable, that it may not exceed the amount of the immediate and heavy financial need, and that the employee agrees to maintain the underlying source documents and provide them upon request.

The attachment also identifies the specific, detailed information that the IRS deems necessary to substantiate particular types of safe harbor hardship distributions. For example, for funeral and burial expenses, the summary must include the name of the deceased, his or her relationship to the participant and date of death, and the name and address of the service provider. Similar lists are provided for the other five types of safe harbor hardship withdrawals.

Thinking of implementing a safe harbor 401(k) plan? Contact your local Armanino expert for more information.

COMMENTS

comments powered by Disqus