What Are the Best Benefits of Safe Harbor 401k?

Were you aware the IRS implements tests of fairness on 401k plans? If you run a business, you likely know all about these tests, and hopefully not because you’ve failed one of them before!

The IRS tests consist of three separate measures to ensure that all employees within a company are being treated fairly with regard to the business’s 401k plan.

A Safe Harbor Provision on a 401k plan ensures that your plan is compliant with these IRS tests and allows you to bypass the testing without any hassle at all.

In this article, we will discuss the three IRS tests in question and outline how a Safe Harbor Provision can help you breeze past these annual requirements.

What are the Three IRS Tests of Compliance?

In essence, the three tests serve to ensure that the most well-paid members of a business are not receiving unfair benefits from the company’s 401k plan.

The tests are as follows:

1. The Top-Heavy Test: This test looks at the balances of the 401k plan. If the owner of the company, along with some of the other highly-compensated employees, maintain the majority of the plan balance (>60%), the plan is considered top heavy.
2. The ADP or Actual Deferral Percentage Test: This test ensures that the deferrals made by highly-paid employees are not significantly higher in percentage of compensation as compared to lower-wage earners in the company. For small businesses, this test is usually the one that is likely to cause problems.
3. The ACP or Actual Contribution Percentage Test: The ACP test is designed to limit employer matching contributions for higher-wage employees as compared to the lower-earners within the business.

Needless to say, if a business fails one or more of these tests, the IRS does not take it easy on them. Heaps of paperwork and hefty fines await those who don’t pass these tests. It’s best to avoid even allowing for the possibility of failing.

How Does a Safe Harbor Plan Protect Businesses?

Safe Harbor Plans are designed with the IRS tests in mind. These 401k plans require that businesses match employee contributions or make nonelective contributions to all employee plans. This way, no one is favored within a retirement plan and everyone is treated fairly, which is what the IRS wants to see in a business’s 401k plan.

How Can I Set Up a Safe Harbor 401k Plan for My Business?

Sadly, the deadline for setting up a brand-new safe harbor 401k plan was October 1^st of 2021. No new plans can be initiated for 2022. Similarly, the deadline for adding a safe harbor provision to an already-in-place 401k plan was on November 30^th, so that deadline has passed as well.

But even though it may be too late to start a plan for 2022, you can get a jump start on your safe harbor 401k plan for 2023. Get all of your documents together now so that you are ready and don’t miss the deadline next year. It will be here before you know it!