Time To Decide On 401(k) Safe Harbor For 2003
Rev. 09/01/02

A safe harbor 401(k) plan may be for you. The safe harbor 401(k) plan allows the employer to avoid the ADP and/or the ACP test. The cost for doing this is a safe harbor contribution. Generally, there are two types of safe harbor contributions. One type is the Safe Harbor 3% Non-Elective Contribution (NEC). The 3% NEC is to be provided to all employees eligible to defer under the plan. The other type of safe harbor contribution is a matching contribution. The safe harbor match may be provided as a basic safe harbor match which is defined as a 100% match on the first 3% deferred and 50% match on the deferrals between 3% and 5%. Alternatively, a safe harbor match may be provided by an enhanced match formula equal to at least the amount of the basic match; for example, 100% of the first 4% deferred. The enhanced match rate may not increase as the percentage of deferral goes up and the rate of match for highly compensated does not exceed the rate of match for the non-highly compensated. Safe harbor contributions must be 100% vested when contributed and may not be withdrawn in-service prior to attainment of age 59½.

The beauty of these contributions is that the ADP and/or ACP test are deemed satisfied and, thus, the Highly Compensated Employees (HCEs) can make a maximum deferral without worrying about passing the tests. This is critically important if the plan has trouble passing the ADP/ACP test and the HCE’s wish to maximize their own deferrals. For 2003, the maximum deferral to a 401(k) plan will be $12,000. In addition, if the participant is over age 50, or will attain age 50 during 2003, a catch-up contribution of $2,000 may also be made.

If the plan is top heavy, the employer can get twice the mileage out of its safe harbor contribution. When a 3% NEC is made to a top-heavy plan, the 3% NEC satisfies the top-heavy contribution requirement. If the plan is making a safe harbor match and the plan is top heavy, the match counts towards satisfying the top-heavy minimum contribution for those employees who receive it. For example, if a participant defers 2% and receives a 2% match, when the employer makes the top heavy contribution, that employee would only have to receive 1% more to satisfy the 3% top heavy contribution requirement. Of particular note is the fact that if the plan’s design allows for only salary deferrals and the safe harbor match contributions, then the plan is exempt from the top heavy rules and, thus, no top-heavy contribution would be required.

If you decide to make your 401(k) plan safe harbor, there are some requirements. Your plan must be amended to add the safe harbor features. You must decide on the 3% NEC or the matching formula. You must provide a safe harbor notice to all eligible employees between 30 and 90 days before the new plan year begins. If this notice is not provided to your employees during the required timeframes, the plan is unable to use the safe harbor provisions for the entire year.

As stated above, the safe harbor notice must be provided 30 to 90 days before the start of the plan year. However, for a brand new 401(k) the safe harbor can be established at the time the 401(k) is established provided the safe harbor notice is given at the time the plan is established. Another requirement for a401(k) plan to become a safe harbor plan is that there must be at least 3 months remaining in the plan year. Adding a 401(k) feature to a profit sharing plan would be considered a new 401(k) plan. If you have an existing 401(k) plan and wish to make it safe harbor, but have missed the deadline to amend the plan and/or provide the notice, then the plan cannot be safe harbored until the following plan year.

One limitation on safe harboring a plan from ACP tests requires that if a discretionary matching contribution is made to the plan, the total amount allocated to participants may not exceed 4% of Compensation provided there is no match of deferrals in excess of 6% of Compensation.

For those employers who have a new comparability plan and who are using the 5% gateway, the 3% NEC safe harbor contribution can perform as the first 3% towards the 5%. In addition, as stated above, if the plan is top heavy, the 3% NEC can serve as the top heavy contribution as well as towards the new comparability gateway while also providing the safe harbor.

For employers who are hopeful but not sure they can afford to provide the 3% NEC safe harbor contribution, there is the flexible 3% NEC safe harbor plan. In this type of safe harbor arrangement, the employer provides the safe harbor notice by the required 30 to 90 days before the start of the plan year. However, in the notice, the employer indicates that he or she may provide a 3% NEC for the next plan year. The employer then has until 30 to 90 days before the end of the plan year to decide on providing the safe harbor 3% NEC and indicate the employer’s decision by providing a notice stating whether the 3% NEC will be given or not.

If the employer finds that the safe harbor matching contribution has become overly burdensome during the year, the employer may stop the safe harbor contributions by providing a notice to the employees 30 days before the safe harbor matching contributions are to be stopped. However, if the employer stops the safe harbor matching contributions before the plan year is completed, the employer must run the ADP and ACP test for the entire plan year. Of course, there is no obligation to make safe harbor contributions every year. The employer could amend the 401(k) safe harbor provisions out of their plan.

These are some of the basics that an employer needs to know before looking into a 401(k) safe harbor plan. Each employer’s goals, plan design, contribution sources and demographics form a unique scenario which the employer will wish to discuss with their plan provider before finalizing the decision to make their plan a 401(k) safe harbor plan.