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Safe Harbor 401(k) Plan

Introduction

In general, the Internal Revenue Code (IRC) requires all "qualified" employer plans to meet certain nondiscrimination requirements, Employer plans established under IRC Sec. 401(k) are subject to one or two additional tests. The first test, applicable to employee deferrals only, is known as the "Actual Deferral Percentage", or ADP, test. The second possible test is the "Actual Contribution Percentage", or ACP, test, and is applied only when there are employer matching contributions.

The Small Business Job Protection Act of 1996 provided 401(k) plans with alternative simplified methods of meeting these additional non-discrimination requirements. 401(k) plans which adopt one of these alternative methods are referred to as "safe harbor" 401(k) plans. A safe harbor plan is very similar to a non-safe harbor plan. The primary difference is how a safe harbor plan satisfies the IRC^’s additional nondiscrimination requirements.

Requirements For A Safer Harbor 401(k) Plan

Effective January 1, 1999, a 401(k) plan which operates as a safe harbor plan must meet one of two employer contribution formulas as well as a written notice requirement:

A. Employer Contributions: One of two employer contribution formulas must be followed:

1. The employer may make a 100% vested contribution of 3% of compensation to all non-highly compensated participants, This contribution formula will also satisfy any "top heavy" requirements_, and may be used in the testing for a non-traditional profit Sharing plan.2 The plan may, but is not required to, provide for a mandatory employer match not to exceed 6% of compensation. The plan may also permit a discretionary match, provided it does not exceed 4% of compensation.

2. As an alternative, the employer may choose to make a 100% vested matching contribution to all non-highly compensated participants who defer under the plan. The match must be 100% of the first 3% of compensation deferred, plus 50% of the next 2% of compensation deferred. The match may also be at the rate of 100% of the first 4% of compensation deferred. Unlike the 3% of compensation formula, discussed above, this formula is considered to satisfy only the deferral discrimination tests. If the employer is making the matching contributions during the year, and the participant changes his or her rate of deferral, the employer may have to "top off" the match after the year ends. Also, under this formula, the employer may make no other types of matching contributions.

Each participant who is eligible to make a deferral must receive a safe harbor contribution. The plan may not have any restrictions on receiving the employer contribution, except the minimum age and service requirements needed for plan participation. Neither a 1000 hour work requirement, nor a requirement that a participant be employed at the end of the plan year, is permitted.

B. Written Notice: To qualify as a safe harbor plan, a 401(k) plan must also provide for written notice to the employees. This requirement has both content and timing elements:

The employer must give notice at least 30 (but not more than 90) days prior to the beginning of the plan year. For plan years beginning prior to April 1, 1999, the notice must be given on or before March 1, 1999

If a plan fails to make the required contribution, or fails to meet any other requirement, it is not a safe harbor plan and is treated like a regular 401(1;) plan₇ subject to the usual discrimination testing requirements.

The safe harbor mechanism must be included in the plan document. However, for 1999, an existing 401(k) plan may function as a safe harbor plan as long as the plan document is amended within the "remedial amendment period" Currently, this is the last day of the plan year beginning in 1999, unless the IRS extends this date. For a new plan_, the employer must include the safe harbor requirements in the plan document.