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A Few Basics of Safe Harbor 401(k) Plans

Sep 5, 2023

Many growing businesses and other types of employers want to offer a 401(k) plan but don’t want to deal with the stress and administrative challenges of following the IRS’s nondiscrimination testing rules for elective deferrals and matching contributions.

One potential solution may be to set up a “safe harbor” 401(k). Such plans aren’t subject to nondiscrimination testing if they satisfy certain contribution, vesting and notice requirements. Here are a few basics on this intriguing retirement benefits option.

Tax details

Employers can deduct employer contributions up to 25% of the compensation of all eligible participants. Participants can exclude their elective deferrals from their income for federal income tax purposes.

As with traditional 401(k)s, the IRS applies a 10% penalty to all early distributions (before the age of 59½) from a safe harbor 401(k). Also, participants cannot withdraw safe harbor money for in-service distributions before age 59½ or for hardship distributions.

Ready for regular

You can choose to stop safe harbor matching contributions and safe harbor nonelective contributions at any time during the year. But you must first amend your plan document to remove the safe harbor provision.

You’ll need to give participants notice of the discontinuance 30 days in advance and allow them to make changes to their deferrals during that period. Because the plan is no longer a safe harbor 401(k), nondiscrimination testing will apply for the entire year.

An idea to consider

Not having to meet nondiscrimination testing requirements makes sense for some plan sponsors, but not all. Be sure you understand all the requirements of a safe harbor 401(k) plan before you undertake the implementation process. Our firm can help you consider the idea from financial and tax perspectives.

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