What is a Safe Harbor 401(k) Plan?
A safe harbor 401(k) plan is a special type of retirement plan designed to ensure all employees have a fair chance to save for retirement. It helps companies bypass strict IRS rules that would otherwise limit retirement savings for owners and highly compensated employees.
Why the IRS Cares About Fairness
The IRS aims to ensure that 401(k) plans are equitable for company employees. This means providing equal opportunities for both company owners and regular employees to save for retirement.
However, this can be tough for small and medium-sized businesses, as owners typically save more than other employees. If the IRS deems a plan unfair, owners may have to withdraw some of their contributions, and the company might need to make additional contributions to other employees.
How safe harbor contributions help
Safe harbor contributions allow owners to save the maximum individual amount ($23,500 for 2024) without running afoul of IRS rules. The company only needs to contribute 3% to 4% of each employee's pay.
This is why safe harbor 401(k) plans are popular for small and medium-sized businesses—they’re easy and fair.
Digging Deeper into Safe Harbor Contributions
There are two ways a company can make safe harbor contributions:
Safe harbor non-elective
What it is: The company contributes 3% of every eligible employee’s wages, even if the employee doesn’t make their own contributions.
Why it works: It’s simple. Everyone gets the same amount, no matter what.
Safe harbor match
What it is: The company matches up to 3.5% of wages (4% if there’s no auto-enrollment) for employees who save their own money in the plan.
Why it works: This incentivizes savings because the company only contributes money if the employee does too.
Which option should your company pick?
It depends on what the company values more:
Non-elective: If the company wants to make sure everyone gets something, this may be a great option.
Match: If the company wants to encourage employees to actively participate in their own retirement savings, this could be ideal.
Both choices benefit employees, so it’s really about what best fits the company’s culture
Conclusion: Safe harbor is the best option for most small businesses
If your company wants to let owners and highly paid employees maximize their 401(k) savings, there are two options: pass the IRS fairness tests or make safe harbor contributions. Failing these tests can be costly. Therefore, most small companies opt for the safe harbor approach. It's a cost-effective strategy that allows everyone to maximize their retirement savings.