Safe Harbor 401(k) Profit Sharing Plans – A Small Business Owner’s Guide to Optimal Tax Strategy and Retirement Savings

Business owners today often feel as if their 401(k) plan can be a necessary evil, required to be competitive in today’s labor environment. The vast majority of 401(k) plans have a deferral component along with some form of matching, allowing an owner (and their employees) to save $23,500 in deferrals along with a 2-6% match.

What owners often don’t know is that their existing 401(k) plan can be amended, and administrated, to allow an owner to save up to $70,000 per year toward their retirement in a tax-advantaged manner.  Often this strategy can be realized for a small increase in employee contributions (which are also tax advantaged)!

A safe harbor profit sharing plan allows a plan sponsor to allocate the maximum defined contribution amount to themselves, while providing anywhere between 3% and 5% of compensation to their employees, between safe harbor non-elective dollars and profit sharing dollars.  Just like a safe harbor match, the plan sponsor doesn’t have to jump through the hoops of an average deferral percentage test for their deferrals.  Instead, an annual non-discrimination test can be run by their administrator.

Census Data

Retirement Contributions

Percent of Employer Dollars to Key Employees - 92.93%

What Is a Safe Harbor 401(k) Profit Sharing Plan?

A safe harbor 401(k) profit sharing plan is a specific type of defined contribution plan that combines the ability for owners to maximize their contributions to the plan with the ability to change allocations every year, dependent upon that year’s goals and cash flows.  The only amount that is required to be contributed every year is 3% of compensation to all the “non-highly compensated employees.”  Once that amount is committed to, the owner gains the ability to defer whatever they wish in 401(k) or Roth deferrals, without refunds.  They also gain the ability to allocate up to the maximum amount of profit-sharing dollars to themselves, often with little or no increase in dollars going to their employees.

Unlike traditional 401(k) plans, the owner is completely unaffected by how much or how little the employees defer into the plan.  No longer do you have to worry about costly or surprising refunds, or hard-to-understand match formulas that you hope your payroll company calculates correctly.

Even better, this plan can serve as an important recruiting tool for your business.  Unlike traditional plans where you match based on an employee deferral, in this plan, you can guarantee candidates 3% of compensation as a contribution into their plan every year.  This often will give you a leg up on your competition for the best candidates in your area.