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What is a Safe Harbor?

A safe harbor 401(k) is a retirement plan that helps small businesses maintain their compliance with Internal Revenue Service non-discrimination standards.

What is the IRS Non-Discrimination Standard?

Each year, the IRS wants to ensure that a business's highly compensated employees do not receive preferential 401(k) treatment over non-highly compensated employees.

Note: As of 2021, a highly compensated employee earns either more than $130,000 or someone who owned more than 5% of the business.

There cannot be a large gap between these two groups regarding what they are depositing into their 401(k) accounts. If non-highly compensated employees contribute small amounts to their 401(k)s, then the highly compensated employees will be limited in what they can contribute.

Another potential pitfall for a 401(k) plan is that it becomes "top-heavy." If key employees (a.k.a. owners or corporate officers) of a business collectively own more than 60% of the total assets in a 401(k), that plan is deemed top-heavy.

If a business does not maintain balance, it could potentially fail the IRS's audit.


Safe Harbor to the Rescue!!!

Safe Harbor 401(k) plans enable companies to automatically pass the IRS compliance testing or skip the compliance testing altogether. In short, the Safe Harbor acts as a promise between the business and the IRS. What is the promise?

Through the Safe Harbor Plan, the business promises to meet a minimum threshold of 401(k) contributions to all its employees. And in return, the IRS will not cap or limit any of the highly compensated employees' contributions.

The IRS ensures that all employees see benefits from the plan instead of an alternate scenario (e.g., the plan acting as a tax shelter for only the key employees). And the business gets to make all employees happy via guaranteed contributions with no upper limits other than the standard $19,500.

This brings us to another important question: what are the rules of a Safe Harbor 401(k)?

Three Types of Safe Harbor 401(k)s

There are three variations of Safe Harbor plans that a business can choose from depending on which makes the most sense for their business and their employees.

Non-Elective Safe Harbor

With a non-elective Safe Harbor, employees get an automatic 3% of their salary contributed to their 401(k) accounts. They do not have to opt-in. It is automatic (i.e., non-elective).

The amount is fully vested regardless of whether the employee contributes to the 401(k) plan.

Safe Harbor Match

With a basic Safe Harbor plan, an employer matches 100% of an employee's contribution up to 3% of the employee's salary and then matches 50% of the next 2% of the employee's salary.

In other words, the employee must contribute to get the match. But the potential match (up to 4%) is higher than the non-elective plan.

These dollars, again, are 100% vested for employees from day 1.

Enhanced Safe Harbor

The enhanced Safe Harbor plan requires an employer to match 100% of an employee's contribution up to 4% (or more) of the employee's salary. In other words, the enhanced safe harbor can enable an employer to provide more contributions to their employees than the basic plan allows.

Safe Harbor Summary

By enacting a Safe Harbor 401(k) plan, an employer guarantees that all of their employees reap the benefits that a 401(k) plan provides. And in return, the IRS allows the company to maintain its standard non-discrimination compliance automatically.


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