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Safe Harbor 401k – Good Or Bad

Safe harbor 401K plans feature simple, alternative methods for meeting discrimination requirements. Created by the 1996 Small Business Job Protection Act, these retirement accounts were created in response to the fact that many businesses were not setting up 401Ks for their employees because the non-discrimination policies were too difficult to understand. These 401Ks give the employer safe harbor from compliance concerns by providing them with a simplified product.
Getting a plan set up is the difficult part. It is not a do-it-yourself project. Even if your tax attorney, financial planner or accountant want to set up a plan for you, it makes sense to at least talk to a professional plan administrator and decide whether having a specialist makes more sense.

Safe Harbor 401k For Dummies

Safe Harbor 401(k) plans tend to be more suitable for companies with predictable revenue streams. If your business may have difficulty finding matching funds on a consistent basis then other 401(k) plans may be a better alternative to the Safe Harbor 401(k). 

If you’re a business owner and your 401(k) has low adoption rates or saving rates among rank-and-file employees, it may raise a flag for the IRS. According to Plan Sponsor Council of America (a lobbying business for the retirement planning industry), most businesses pass the test, but around 40 percent claim to have reported refunding or restricting plan contributions to do so. 

There are even alternatives to a safe harbor 401(k). A business can structure a plan to be age-based, so that the investors closest to retirement can receive more in employer contributions. There is also something called a new comparability plan, that breaks the employees up according to classes or tiers, with older or key employees being given a larger profit share. Find someone who understands the various options, can explain them to you and then finds a way to maximize contribution limits for you and other key employees. 

What’s Safe Harbor 401k

To find a 401(k) or customized retirement plan for your small business, the 401k Help Center offers a list of retirement plan providers. You can also ask fellow business owners or financial professionals in your area for local favorites. Plan factories are not necessarily better than knowledgeable experts who live in your area. When looking for safe harbor, it pays to shop around. 

A long vesting schedule is not allowed with safe harbor plans, contributions are fully vested when made. This means you have to give all employees their share — even those who leave or are fired during the year. You can design your plan to limit matching contributions to only those employees that defer compensation, or make contributions for everyone, including those employees who do not contribute to their own plans.

Why Safe Harbor 401k

Safe harbor provisions appear in a number of laws or contracts. For example, under SEC rules, safe harbor provisions protect management from liability for making financial projections and forecasts in good faith. Similarly, individuals with websites can use a safe harbor provision to protect themselves from copyright infringement cases based on comments left on their websites.

Because of this, tax filers had to review a long list of requirements to determine into which category their expenses fall, and the process was confusing. To eliminate confusion, the IRS created a safe harbor accounting method for eligible retail and restaurant businesses. Essentially, these businesses can now choose if their remodeling costs fall into the repair or capitalized improvement categories. Due to this safe harbor, businesses don’t have to worry about accidentally making the wrong selection and later being penalized for it.

Safe Harbor 401k

Typically, the Internal Revenue Service (IRS) requires taxpayers to treat remodels as capitalized improvements, the value of which generally must be claimed slowly over a long period of time. However, restaurants and retailers often remodel their facilities on a regular basis to help their businesses look fresh and engaging. As a result, the IRS has allowed some restaurateurs and retailers the ability to claim these expenses as repair costs, which could all be deducted as business expenses in the year they are incurred.

The IRS wants to see that all employees are taking advantage of the retirement plan, not just those with the high paying jobs. So it tests the plan to find out if the average contributions of highly compensated employees (those who earned at least $120,000 in 2016 or own more than a 5 percent stake in the business) do not exceed the average contributions of everyone else by more than 2 percent. 

What Does Safe Harbor 401k Mean

It may be a small price to pay for insurance that your own plan will pass muster. If your plan already includes matching 401(k) contributions, you may already be safe. A safe harbor provision can be attached to any type of retirement plan or 401(k). But it requires a lot of written notification and education for plan participants. And they must receive these documents within 30 to 90 days of beginning employment. Once you get a plan set up, it should be easy enough to execute. 

Why Use Safe Harbor 401k

A safe harbor 401(k) is a way to structure a plan that automatically passes the non-discrimination test or avoids it altogether. It’s relatively easy to do, but the employer must make contributions to each employee’s plan — the same percentage of salary for everyone. For example, for every contribution made by an employee, the company adds another 5% of their salary. The amount you match will depend on your own contributions as a business owner. 

Then you or your employee will owe federal and state income tax on the money. There could also be a 10 percent penalty fee. If the plan can’t be fixed through refunded contributions, there’s a risk that your entire 401(k) savings will be refunded. (There’s a fascinating story by the 401k Help Center, describing one employee’s feeling of uncertainty after his employer’s plan has failed a nondiscrimination test.) It would be your retirement plan’s worst day, and could really discourage or stymie the savings of small business owners and their employees.


Updated: July 22, 2017 — 8:53 am
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