What is a safe harbor 401(k) plan? Guide for business owners

At Human Interest, we support different kinds of 401(k) designs for small businesses. One plan design we recommend quite often is the safe harbor 401(k) because it’s a great way for employers to reward employees and simultaneously save themselves tons of administrative hassle. So, what’s so special about a safe harbor plan? Let’s review.

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What is a safe harbor 401(k) plan?

A safe harbor 401(k) plan is designed to ensure that all eligible participants receive an employer contribution, while also providing benefits to employers. By offering a fixed employer contribution, employers can avoid key 401(k) nondiscrimination tests, which are used by the IRS to ensure that the plan is fair and equitable for all employees.

What are the requirements of a safe harbor plan?

Any 401(k) plan can be designed to include a safe harbor contribution. When considering a safe harbor plan design, employers should understand that the employer contribution is a fixed, mandatory contribution. In most cases, the employer contribution is required to be immediately 100% vested. Also, there are restrictions on amending a safe harbor plan mid-plan year (more on this below).

For new 401(k) plans, timing restrictions will dictate the type of safe harbor plan design available in the initial (or first) plan year. If you currently have a 401(k) plan that’s not safe harbor, you may have to wait until the next calendar year to be able to add a safe harbor provision.

The three safe harbor contribution formulas 

There are three basic “types” of safe harbor 401(k) plans. You must meet ONE of the following for your plan to be considered a legal safe harbor plan (unless you use a QACA formula as described later):

1. Basic match: Company matches 100% on the first 3% of deferred compensation, plus a 50% match on the next 2% of deferred compensation. 

2. Enhanced match: Company match that’s at least as generous as the basic match at each tier of the match formula. A common formula is 100% match on the first 4% of deferred compensation. 

3. Non-elective: Company contributes 3% or more of each employee’s compensation, regardless of whether the employee makes elective deferrals.

Employer safe harbor contributions must be immediately 100% vested. For more information, read our guide on safe harbor contribution options.

Qualified automatic contribution arrangement (“QACA”)

All safe harbor plan designs may include an automatic contribution arrangement (ACA), which treats an employee who fails to make an election as having elected to defer the default percentage set by the plan. The employee can opt out of the default at any time. A specific combination of safe harbor required contributions and ACA provisions make a plan a QACA plan. Unlike other safe harbor designs, QACA plans are permitted to use a two-year cliff vesting schedule for employer safe harbor contributions. Some employers are willing to jump through additional design hurdles to take advantage of this two-year vesting schedule.

Which safe harbor contribution formula to consider?

A safe harbor match design is best suited for employers that want to actively encourage employees to save by motivating them with the matching employer contribution. An employee will only receive a safe harbor match contribution if they make employee elective deferrals to the plan. At Human Interest, the 4% safe harbor match is the most common type of match among our customer base*.

Companies that want to go above and beyond for their employees can offer a higher percentage match and still qualify for safe harbor.  Non-elective contribution safe harbor designs are more expensive for the employer because every eligible employee gets an employer contribution, regardless of their choice to make employee elective deferrals. Despite the extra cost, there are times when a nonelective formula makes the most sense for an employer, due to: 

1. Timing restrictions when implementing a new safe harbor design 

2. HR issues related to recruiting and retaining employees

3. Plan design issues that make having a nonelective contribution beneficial to the employer 

Because safe harbor contributions must be made annually, companies are implicitly required to have strong cash flow to meet their commitments. Actively managing your company’s safe harbor 401(k) plan can help ensure your company can make contributions in full and on time.

*Human Interest internal data, 2022

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Safe harbor 401(k) deadlines

Safe harbor plans have strict deadlines. We recommend communicating with your service provider as early as possible to determine if there are any timing limitations at the service provider level, in addition to the legal deadlines, that may restrict your ability to implement the safe harbor plan design of your choice. Timing restrictions to be aware of include:

Deadlines for new plans: 

• The first year (“initial year”) of a new safe harbor 401(k) plan (for both match and nonelective type designs) must be at least three months long, meaning the opportunity to make elective deferrals from wages must be available for at least three months in the first plan year. This means the deadline to establish a new calendar year based plan is October 1. 

Deadlines for a safe harbor match design in the initial year: 

• September 1: Deadline to send out safe harbor notice to employees

• October 1: Deadline to include safe harbor match provision

• Any deadline set by service provider to prepare plan documents in advance of other mandatory deadlines  

Deadlines for a safe harbor nonelective design in the initial year: 

• December 1: Deadline to add 3% nonelective contribution safe harbor design for initial year*

• December 31 of following plan year: Deadline to add 4% nonelective contribution safe harbor design for initial year. 

• Any deadline set by service provider to prepare plan documents in advance of other mandatory deadlines 

*Keep in mind that in order to take advantage of the safe harbor nonelective opportunities in the initial plan year, the plan must provide a deferral opportunity of at least 3 months to participants.

Deadlines for existing plans (not in their initial year) - Adding safe harbor design or modifying safe harbor provision:

• An existing 401(k) plan may be amended to add a safe harbor design or to change the safe harbor design already in place. 

• The type of safe harbor design permitted depends on the timing of the amendment. 

• Existing 401(k) plans cannot add or modify safe harbor match design provisions in the middle of the year while a nonelective safe harbor contribution design has more flexible timing requirements. 

Deadlines for adding or modifying a safe harbor match design (includes switching from existing safe harbor nonelective to safe harbor match design):

• December 1: Deadline to send out 30-day notice to employees

• January 1: Safe harbor match contribution design becomes effective

• Any deadline set by service provider to prepare plan documents in advance of other mandatory deadlines  

Deadlines for adding or modifying a safe harbor nonelective design:

• December 1: Deadline to add 3% nonelective safe harbor design for current year. Must be retroactively effective to January 1.

• December 31 of following plan year: Deadline to add 4% nonelective safe harbor design. Must be retroactively effective to January 1 for the plan year in question.

Additional restrictions on safe harbor plans

Some changes to a safe harbor plan are always prohibited mid-year, while other changes may be permitted if certain requirements are met. There are also restrictions on mid-year reduction or suspension of safe harbor contributions. Any permissible change will require advance notice to employees and may also subject the plan to nondiscrimination testing for the full plan year. 

An employer that chooses to add a safe harbor design to its 401(k) plan should be aware of these restrictions. It should also be aware that the rules regarding mid-year changes are complex, and may require the employer to seek guidance from a service provider or an attorney. 

Safe harbor contribution limits

Basic employee deferral limits for safe harbor 401(k) are the same as a traditional 401(k) plan. In 2024, these contribution levels are $23,000 ($30,500 for those aged 50 and over). What’s more, safe harbor provisions enable owners and highly compensated employees (HCEs) to max out deferrals without risking nondiscrimination failure.

When should your company consider a safe harbor plan?

Safe harbor plans are beneficial for both employers and employees, as we’ll describe in the next section. But there are certain circumstances when safe harbor plans are even more advantageous:

• If your company’s 401(k) plan has recently failed nondiscrimination or compliance tests and you want a stronger guarantee of passing results in the future.

• Your company’s HCEs want to be able to contribute more to the 401(k) plan without risking nondiscrimination testing failure.

• Your current plan is “top-heavy,” or has 60% of more of the plan assets allocated to key employees.

• Your current 401(k) plan has a low level of engagement among your non-HCEs due to factors such as personal financial insecurity or an inability to contribute.

• You have recently been required to make employer contributions to keep your plan passing or compliant.

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Safe harbor plans and key employees

Safe harbor plans are particularly valuable for small and medium-sized businesses, especially if your key employees want to actively contribute to the company 401(k) plan. 

For small companies: If key employees contribute heavily to the 401(k), the plan is at risk of being top-heavy. If a plan is top-heavy, employers must make a top-heavy minimum allocation (additional employer contribution) to non-key employees. This can be an unexpected and expensive issue for an employer. Plans that use a safe harbor design are deemed to pass top-heavy testing as long as there’s not a separate profit-sharing contribution made to the plan. 

In these cases, adding a safe harbor contribution to the plan will allow key employees to make their preferred level of contributions and protect the employer from having to make additional top-heavy contributions. If the plan includes profit-sharing contributions, adding a safe harbor contribution will not eliminate top-heavy testing or the risk that top-heavy contributions will be required. However, if the plan is top-heavy, the safe harbor contributions can be used to offset all or part of any top-heavy minimum contribution you may owe to non-key employees. 

For companies with 50-80 employees: Even at companies with dozens of employees, non-HCEs may not be contributing enough for HCEs to max out their 401(k) contributions. However, a safe harbor plan provides the freedom to contribute more fully without jeopardizing the standing of the company’s plan. This can help incentivize key HCEs to continue their employment with your company instead of looking for more flexible benefit offers elsewhere.

Benefits of having a safe harbor 401(k) plan

Remember, the government wants to encourage and incentivize 401(k) plans by offering tax benefits to both employers and employees; however, it also wants to ensure employers are not taking advantage of tax benefits while excluding employees. That’s why the IRS administers 401(k) nondiscrimination testing. The benefits of safe harbor plans include:

• Automatically pass key nondiscrimination tests and satisfy top-heavy testing if employer contributions are limited to those that satisfy the ADP and ACP safe harbor tests.

• Allow all employees to contribute the maximum allowable amounts to their 401(k).

• Incentive employees to save for their future (in general, employer matches can help increase employee participation rates). 

• Gain an advantage in recruiting and retaining employees (the company won’t have to restrict employee contributions from HCE and company owners or monitor contributions from non-HCEs).

• Benefit from employer contributions, which are tax-deductible for the company. 

• Benefit from small business tax credits. With Secure Act 2.0 signed into law on December 29, 2022, small businesses with up to 50 employees may be eligible for a tax credit to cover 100% of plan start-up costs for a workplace plan (up from 50%) capped annually at $5,000 per employer (which remains unchanged) for each of the first three years. Eligible businesses with 51 to 100 employees are still subject to the original SECURE Act’s tax credits equal to 50% of administrative costs, capped annually at $5,000 per employer for three years. You may also claim an additional $500 tax credit per year for a three-year period by adding an automatic enrollment feature to either a new or existing 401(k) plan. In total, this could result in $16,500 in savings over three years.

Disadvantages of a safe harbor 401(k) plan

• Under the safe harbor match, you need to commit to the plan for one year. 

• Safe harbor match design plans must send out an annual notice, at least 30 days before the new plan year begins.

• There’s a termination fee charged by some 401(k) providers if you ever change your mind and decide to stop offering safe harbor.

• It can be relatively expensive, depending on the salaries of your employees.

Essentially, a safe harbor plan’s main benefit is convenience—as it offers less testing hassle and more flexibility in contributions. However, the downside is that it’s not free and comes at a slight cost in terms of administrative work, as well.

How much does a safe harbor 401(k) plan cost?

The more employees you have, and the higher their salaries are, the more expensive a safe harbor 401(k) will be for your company. If you offer a non-elective safe harbor plan, it will be easier to calculate the total budget for the plan because it is that percent of your total payroll. For instance, companies offering a 3% non-elective contribution, with 10 employees each earning $60,000 each, would contribute $60,000 x 10 x 3% = $18,000 total.

How much does a 401k cost an employer?

For the safe harbor match, total cost will depend upon employee contributions—so it’s more difficult to predict, but typically cheaper overall (in terms of employer cost) than a non-elective safe harbor. 

Use our safe harbor calculator to get a better idea of how much a plan will cost your business.