Traditional safe harbor contribution requirements 

The ADP and ACP tests are performed each year to make sure a 401(k) plan doesn’t favor its highly compensated employees (HCEs) over its non-highly compensated employees (NHCEs). A plan sponsor is deemed to satisfy—and thus, effectively avoids—the ADP test, if it adopts one of the following safe harbor employer contribution formulas for its 401(k) plan and meets the other requirements discussed later.

An employer can adopt a nonelective contribution safe harbor plan up until 30 days before the plan’s year-end. If the nonelective contribution is at least 4% of compensation, the employer has until the last day of the following year to adopt the safe harbor plan design. One benefit of being able to wait 11 months is that it gives employers time to see how likely it is that they'll pass the ADP and ACP tests without the safe harbor nonelective contributions. Additionally, if a plan is top-heavy, there may be very little additional cost to making a safe harbor nonelective contribution rather than the minimum employer contribution required by the top-heavy rules.

A plan sponsor can avoid the ACP test with respect to matching contributions if its 401(k) plan meets the ADP safe harbor requirements and uses:

• The basic safe harbor matching formula, and no other matching contributions are provided under the plan.
• The enhanced safe harbor matching formula, but doesn't match elective deferral contributions in excess of 6% of an employee’s compensation, and no other matching contributions are made under the plan.
• Other matching contributions formula as long as:

o   The contributions aren't made with respect to elective deferral contributions or after-tax employee contributions that, in the aggregate, exceed 6% of an employee’s compensation.

o   The rate of matching contributions doesn't increase as the rate of elective deferral contributions or after-tax employee contributions increases.

o   The rate of matching contributions with respect to any HCE’s elective deferral contributions or after-tax employee contributions isn't greater than the rate of matching contributions for any NHCE.

Qualified automatic contribution arrangements (QACAs)

Internal Revenue Code (IRC) Section 401(k)(13) offers an alternative safe harbor, but it’s only available to plans that have automatic enrollment and automatic increase features and can satisfy the definition of a QACA. Certain qualified automatic enrollment plans that satisfy the requirements under IRC Section 401(k)(13) may be exempt from ADP/ACP testing. In some cases, top-heavy testing isn't required if no additional employer contributions are made.

Employees must be initially enrolled between 3% and 10% of compensation, with the default deferral percentage being at least 3%. Deferral contributions must automatically increase annually by 1% after the first full plan year if the initial rate is less than 6% of compensation. In fact, SECURE Act 2.0 mandates that most 401(k) plans established after December 29, 2022, include automatic enrollment provisions, which allow for using a QACA, by January 1, 2025. A key update also includes raising the automatic escalation cap to 15% (up from 10%).

QACA safe harbor contributions

• Basic matching formula—The formula is 100% match on the first 1% of compensation deferred, plus 50% match on the next 5%. Therefore, the required match is 3.5% of compensation and is spread out over deferrals equaling 6%.
• Enhanced matching formula—Similar to the traditional safe harbor contribution requirements, the QACA safe harbor requirements allow an enhanced matching formula that provides a match no less than the matching contribution an employee would receive under the basic formula at any rate of deferral. The match rate for HCEs may not be greater than the match rate for NHCEs at each contribution level and can’t increase as employee contributions increase. In addition, employee contributions greater than 6% of compensation can't be matched.
• Nonelective contribution—The QACA plan design also allows for a nonelective contribution described above.

Eligible employees

Safe harbor matching contributions

For a plan to meet the 401(k) safe harbor requirements, all participants making elective deferrals must receive the safe harbor matching contributions. A plan can't impose any additional eligibility requirement for the safe harbor contribution. For instance, some plans require that a participant be employed on the last day of the year or have at least 1,000 hours of service in a plan year to be entitled to employer contributions. These plans wouldn't satisfy the safe harbor requirements.

Of course, a plan may continue to have initial eligibility requirements for participation. But once an employee is eligible to participate and makes an elective deferral, they must also be entitled to the safe harbor matching contribution. Plans may fund a safe harbor contribution on a more frequent basis than the determination period. If, for example, a plan uses a plan year determination but funds the contribution each payroll period, a true-up at year-end is required. Conversely, a plan that specifies a determination period of each payroll period may not true up at the end of the plan year unless a separate employer match is permitted in the plan document.

Safe harbor nonelective contributions

All participants eligible to make elective deferral contributions must receive the safe harbor profit sharing contributions, regardless of whether they actually contribute to the plan. As with safe harbor matching contributions, a last-day or hours requirement can't be imposed.

Age and service rules

A 401(k) plan otherwise meeting the safe harbor requirements isn't required to provide safe harbor contributions to participants who haven't yet attained age 21 and completed a year of service. To the extent these participants make deferrals and receive matching contributions under the plan, they’re simply subject to the standard ADP and ACP tests, while the remaining participant population wouldn't be subject to these tests. The plan, however, must specifically provide that elective deferrals and any matching contributions for such participants satisfy the ADP and ACP tests.

Vesting requirements

• Traditional safe harbor contributions—All traditional safe harbor contributions must be 100% immediately vested, except if the plan uses a matching formula other than the basic or enhanced formula. There’s no vesting requirement for other matching contributions described above.   
• QACA—A QACA allows employers to use a two-year cliff vesting schedule for safe harbor matching or nonelective contributions, meaning employees are 0% vested until they complete two full years of service, at which point they become 100% vested. A more liberal vesting schedule may be applied. A two‑year schedule can benefit plan sponsors with turnover before year two, as they can use the forfeitures generated to help offset the required match.
• Non-safe harbor contributions—Non-safe harbor contributions in the same plan can continue to be subject to any permissible vesting schedule.

Distribution restrictions 

Similar to elective deferrals, safe harbor contributions may not be distributed generally before a participant attains age 59½ or separates from employment. As of 2019, the regulations permit (but don't require) 401(k) plans to allow hardship withdrawals of safe harbor contributions, matching contributions, and related earnings that meet an immediate and heavy financial need in addition to elective deferrals. 

True-up contributions 

Generally, safe harbor contributions are based on a participant’s compensation for the entire plan year. As a result, an employer may have to make an additional contribution (sometimes called a true-up contribution) at the end of the plan year if the employer made periodic matching contributions more frequently than annually. The same is true if a different measurement period is chosen. For example, if the safe harbor contribution is based on a participant’s compensation for a calendar quarter, a quarterly true-up would be required. If the plan specifically provides that the matching contribution will be determined on a payroll basis, however, no true-up matching contributions are needed. If the per-payroll method is chosen, the employer must make the matching contribution no later than the last day of the plan year quarter following the plan year quarter in which the elective deferral to which it relates falls.

Notice requirements

All eligible employees must be given an annual notice that the plan will make a safe harbor contribution. The notice must:

• Inform employees of their rights and obligations under the plan
• Be written in a manner calculated to be understood by the average employee
• Include the plan’s contribution formula, the deferral election procedures, the plan’s withdrawal and vesting rules, and certain other information

Timing

Generally, all eligible employees must receive the notice at least 30 days and no more than 90 days before the beginning of each plan year for which the safe harbor contribution will be made. Under certain circumstances, the employer can wait until 30 days before the last day of the plan year to use the safe harbor nonelective contribution method.

Exceptions for nonelective contributions

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, effective for plan years beginning after December 31, 2019, significantly reduced the administrative burden for 401(k) plans that use nonelective contributions to meet safe harbor requirements. The Act eliminated the need for these plans to provide the annual notice to employees. Key details regarding the SECURE Act and eliminating notice requirements for nonelective contributions include:

• Plans that provide a 3% nonelective contribution to all eligible employees (and not a matching contribution) aren’t required to send the annual safe harbor notice.
• QACAs that use safe harbor nonelective contributions are also exempt from the notice requirement.
• This exception applies even if the employer waits until later in the year to decide to make the nonelective contribution. 

Plan amendments

If you decide to turn your 401(k) into a safe harbor plan, you must amend your plan document to specifically provide that it intends to comply with the safe harbor requirements. Generally, such amendments must be adopted before the first day of the plan year to which they'll apply. A later adoption date may apply for the nonelective safe harbor contribution amendment as described above.

Simplify plan administration with a safe harbor 401(k)

The primary drawback of the 401(k) safe harbor feature is the higher cost of contributions for plan sponsors. However, for plan sponsors that have encountered difficulty and incurred extra costs in running and rerunning their annual ADP/ACP tests, or failed the annual top-heavy test, the cost and complexity concerns are likely to be outweighed by the advantages of dispensing with these tests entirely. Plus, the safe harbor plan design can help improve participants’ retirement readiness. If you think the 401(k) safe harbor plan design may be advantageous for your plan, contact your financial professional, plan consultant, or third-party administrator for assistance.

FAQs

What are the safe harbor contribution options for a 401(k)?

Safe harbor contribution options for a 401(k) include three approaches. The basic matching formula provides 100% on the first 3% of compensation and 50% on the next 2%. Enhanced matching formulas must be at least as generous as the basic formula at every deferral level. Alternatively, employers can make a nonelective contribution of at least 3% of compensation to all eligible employees, regardless of whether they contribute to the plan.

Is a safe harbor 401(k) mandatory for employers?

No, a safe harbor 401(k) isn't mandatory for employers. It’s an optional plan design that can eliminate annual nondiscrimination testing if certain requirements are met. Employers typically adopt safe harbor status when their plans struggle to pass the ADP and ACP tests. The trade-off is making required matching or nonelective contributions to all eligible employees.

What’s the difference between QACA and traditional safe harbor plans?

The primary difference between QACA and traditional safe harbor plans is vesting and automatic enrollment. QACAs require automatic enrollment with default deferrals between 3% and 15% of compensation and automatic annual increases. They allow a two-year cliff vesting schedule, while traditional safe harbor plans require immediate 100% vesting. QACAs also have a lower matching requirement—3.5% of compensation spread over 6% of deferrals—compared to the traditional 4% match.

Can a plan switch to a safe harbor midyear?

Yes, plans can switch midyear, but only with a nonelective contribution safe harbor. Employers can adopt this plan design up to 30 days before the plan’s year-end. If the nonelective contribution is at least 4% of compensation, they have until the last day of the following year to adopt it. This flexibility allows employers to wait and see if their plan will pass nondiscrimination testing before committing to safe harbor contributions.