Every October, the IRS publishes the annual retirement plan limits. Some of these limits provide in part; the maximum individual contribution to a Solo 401k, 401(k), 403(b) or 457 plan; the maximum compensation considered for allowances and deductions from the retirement plan; and the limits of social security.

Investment representatives and retirement service providers will hail the new limits as an opportunity for employees to save more money in their tax-deferred retirement plans. Following that advice can be a mistake for highly paid employees and could cost your employer additional fees.

Following the advice, highly paid employees with higher levels of discretionary income would increase their contributions. Low-compensated employees with little discretionary income will keep their contributions at current levels. The net result is a failed average deferral percentage test with post-refunds at additional and highly offset employer fees.

Rather than just touting the new plan’s contribution limits, investment representatives should include the benefits of the “Safe Harbor” plan design with them.

Adopting a safe harbor 401(k) plan design allows an employer to avoid discrimination tests of employee elective deferral rates and/or employer matching contributions (ADP/ACP tests). The benefit of avoiding the test is to maximize contributions for the highly compensated.

In general, there are two types of safe harbor designs.

One type is the non-elective safe harbor design of 3% of the compensation. Generally, a 3% contribution is provided to all employees eligible to make elective deferrals to the plan. The guaranteed contribution requires a 3% employer contribution to be made each plan year, unless the employer amends the plan and removes the provision before the start of the new plan year. 3% corresponds to 100% of the employees.

The other type of safe harbor design is a matching contribution. There are two options to choose from, basic or enhanced matching. The basic Safe Harbor Match Contribution is defined as a 100% match on the first 3% deferred and a 50% match on deferrals between 3% and 5%. Alternatively, the employer may choose an enhanced match formula equal to at least the amount of the basic match; for example, 100% of the first 4% deferred.
Safe Harbor 401(k) plan provisions cannot be added to an existing 401(k) plan in the middle of the plan year. Instead, the plan must be amended from time to time to add 401(k) safe harbor provisions for the next plan year.

As an exception to the time requirements for giving the safe harbor notice, a new 401(k) may adopt a safe harbor design at the same time the plan is established, assuming the notice is given concurrently. There must be at least 3 months remaining in the plan year to make elective deferrals for a plan to use this provision. An existing profit-sharing plan that is modified to add a 401(k) feature is eligible to use this rule.

Additionally, a greenfield business entity establishing a new 401(k) plan may have an initial plan year of as little as one month (assuming the initial year is followed by the normal 12-month year).

A plan sponsor using a guaranteed 3% must make that contribution regardless of their subsequent financial condition during that plan year. However, an employer may stop making safe harbor matching contributions by notifying employees. This notice must be given at least 30 days before contributions are to stop. If an employer stops safe harbor matching contributions before the plan year is complete, the ADP and ACP tests must be taken for the entire plan year.

Investment representatives who plug annual plan limits into a “safe harbor” plan design will end up providing their clients with three benefits: higher contribution levels for the highly compensated, no ADP/ACP testing hassle, and customer satisfaction. any major issues. That is has triple play.