Safe harbor contribution options: Learn about the 3 different types

Safe harbor 401(k) plans are designed to benefit employees and employers. Adding a safe harbor provision to a 401(k) plan provides all eligible plan participants with an employer contribution. In exchange, businesses can avoid key annual IRS nondiscrimination testing.

Any 401(k) plan can be designed to include a safe harbor contribution, but companies must choose from several required contribution types. The right 401(k) safe harbor contribution formula is a critical step for companies aiming to minimize or remove compliance failures and increase employee satisfaction. This article reviews safe harbor contribution options, but you can refer to our guide to brush up on the basics of safe harbor 401(k) plans.

What is a safe harbor contribution?

It’s natural to have questions about safe harbor contributions, as there are a few different methods and formulas. All safe harbor provisions in a 401(k) plan require employers to contribute either a matching contribution or a nonelective contribution to eligible employees' retirement accounts. Safe harbor contributions are required to be 100% immediately vested. In turn, they allow businesses to bypass complex annual nondiscrimination tests by ensuring fair contributions to all employees.

There are three basic formulas for safe harbor 401(k) plans:

1. Basic match

2. Enhanced match

3. Non-elective

Below, we’ll explore the specifics of the safe harbor contribution formulas.

1. Safe harbor basic match

This formula matches employee contributions dollar-for-dollar up to 3% of the employee’s compensation and 50 cents on the dollar for the next 2% of compensation. So, if an employee contributes at least 5% of their salary to their 401(k), they receive the maximum employer contribution of 4%. Safe harbor basic match is considered to be the least expensive safe harbor contribution options.

Example: Consider an employee earning $100,000 annually. If the employee contributes 5% ($5,000), the employer matches the first 3% ($3,000) dollar-for-dollar, and then 50% of the next 2% ($1,000), totaling $4,000.

Benefits of the basic safe harbor match

A basic safe harbor match offers advantages for both employers and employees. For employers, it can help simplify compliance and enhance talent attraction and retention. Meanwhile, your employees receive a clear incentive to save for retirement. As a bonus, the guaranteed employer contribution also encourages long-term financial security.

2. Safe harbor enhanced match

The safe harbor enhanced match is a more generous matching formula compared to the basic match. Employers match 100% of employee contributions up to a certain percentage, between a minimum of 4% or a maximum of 6%, of the employee’s compensation.

Example: Consider an employee who earns $100,000. If the employer offers a 100% match up to 5%, the employee must contribute 5% ($5,000) to receive the full employer match of $5,000.

Comparison: Basic vs. enhanced safe harbor match

The main difference between the basic and enhanced safe harbor match is the benefits to employees. The latter is considered more generous and often provides a higher total contribution from the employer. Additionally, an enhanced safe harbor match may incentivize employees to contribute more of their salary to maximize their match — a plus if you are looking for ways to encourage 401(k) plan enrollment.

3. Safe harbor non-elective contribution

Safe harbor non-elective contribution is a type of employer contribution to 401(k) plans that provides a flat percentage of each employee's compensation, regardless of whether the employee contributes to their 401(k). Here, your company must contribute a minimum of 3% of each eligible employee’s compensation. This formula is considered to be the most expensive of the safe harbor contribution options.

Common scenarios for choosing non-elective contributions

There are a few reasons companies may opt for non-elective contributions for their safe harbor 401(k) plans. Some employers might choose this option to benefit employees who do not or cannot contribute to their 401(k). Or, others use non-elective contributions because it provides a uniform contribution rate for all eligible employees.

Qualified automatic contribution arrangements (QACAs)

QACAs are a type of safe harbor 401(k) plan that includes automatic enrollment of employees into the plan—with a specified default contribution rate—in exchange for exemption from specific year-end compliance testing requirements. Unlike other safe harbor match designs, a QACA plan is permitted to use a two-year cliff vesting schedule for employer safe harbor contributions.

Requirements and benefits of QACAs

• Automatic enrollment: Employees are automatically enrolled at a default contribution rate, which must be at least 3% and increase annually.

• Employer contribution: The match required in a QACA is slightly different from that required in a regular safe harbor plan. It requires that the employer match 100% of the first 1% of compensation contributed, plus 50% on the next 5% of compensation. Alternatively, a 3% nonelective may also be contributed to the plan.

• Benefits: Increases overall employee participation and can be subject to a two-year cliff vesting schedule, versus 100% immediate vesting for non-QACA safe harbor plans.

The two main differences between QACAs and other safe harbor plans are that automatic enrollment is mandatory and vesting schedules (up to two years) are allowed.

Tests you can avoid with a safe harbor 401(k)

All companies with 401(k) plans are subject to meeting compliance requirements, including IRS-mandated nondiscrimination testing. These are designed to ensure that the plan does not disproportionately favor highly compensated employees (HCE) or key employees (generally individuals who hold a certain level of influence or responsibility within the company) over non-highly compensated (NHCE) employees. The tests include:

• Actual deferral percentage (ADP): This test compares the average percentage of salary deferred by participating HCEs to that deferred by NHCEs, revealing the relative engagement of each employee type. It ensures that HCEs do not defer a disproportionately high percentage of their pay compared to NHCEs. If this test fails, employers must decide to either return excess deferrals to HCEs or contribute a QNEC to NHCEs to balance the deferral averages between the two groups.

• Actual contribution percentage (ACP): Similar to the ADP test, but focusing on employer matching and after-tax contributions, this test applies to companies offering a 401(k) match or after-tax contributions. It uses the same calculations and breakdowns as the ADP test but includes employer match and after-tax contributions when determining the average contribution rate for HCEs and NHCEs. If this test fails, employers must decide to either return the excess match to HCEs or contribute a QNEC to NHCEs to balance the match averages between the two groups.

• Top-heavy test: This test ensures that key employees do not hold more than 60% of the total plan assets. Although not technically a nondiscrimination test, it may require additional contributions to participants, so it's important to understand. The top-heavy test compares the account balances of key employees to those of non-key employees, using data from the last day of the previous 12-month testing period. If this test results in 60% or more of assets belonging to key employees, the plan is considered “top-heavy” and a minimum 3% employer contribution may be required.

Note: Safe harbor plans are only exempt from the top-heavy test if, for the year the plan is top-heavy, the only employer contributions to the plan are the required safe harbor contributions. If an additional employer contribution is made (which could be profit sharing, reallocated forfeitures, or a discretionary match), the exemption is no longer met, and the plan may be required to fund a top-heavy minimum contribution.

What’s the difference between safe harbor and employer contributions?

Match formulas are not created equal. While both safe harbor and traditional employer matches involve contributions to employees' 401(k) accounts, the key difference lies in compliance requirements.

Safe harbor contributions allow plans to automatically satisfy key IRS non-discrimination tests, while traditional employer matches require annual testing. In addition, traditional safe harbor contributions are immediately 100% vested. QACA safe harbor contributions may be subject to a maximum two-year vesting schedule, whereas discretionary employer matching contributions can be subject to a maximum six-year graded or three-year cliff vesting schedule.

When can a plan add a safe harbor provision?

Provisions such as safe harbor, QACA match, or non-elective must be added at the beginning of the plan year, or as soon as a new plan is established. However, traditional safe harbor non-elective contributions can be added anytime mid-year, as long as they are retroactive to the first day of the plan year. This is because there’s no requirement to participate in the plan to receive the funds.

Note that if you add a nonelective after 12/1 of the current plan year, the minimum allocation percentage increases from 3% to 4%. However, you may find that adopting this provision retroactively will benefit your employees, as it’s an option to bypass HCE refunds from the ADP and ACP tests after compliance testing results are released.

Crunch the numbers and find safe harbor for your business

The main types of safe harbor contributions—the basic match, enhanced match, and non-elective contributions—each offer unique benefits for compliance and employee retention. Need help selecting the right safe harbor plan? Try out Human Interest’s safe harbor contribution calculator to help determine the best option for your business.