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How Safe Harbor 401(k) Plans Work


A 401(k) plan is a widely used type of employer-sponsored retirement plan that allows employees to set aside pre-tax dollars for their retirement. Safe harbor 401(k) plans are a special type of 401(k) plan that small businesses use. Though there are trade-offs, safe harbor 401(k) plans provide small business owners who want to offer a retirement savings plan to their employees a way around specific IRS tests.

A financial advisor could help you put a financial plan together for your retirement needs and goals. 

How Safe Harbor 401(k) Plans Work

SmartAsset: How Safe Harbor 401(k) Plans Work

In most ways, a safe harbor 401(k) operates like any other 401(k). The employer sponsors the plan and employees choose whether or not to participate. Participants deposit money before taxes apply and decide how to invest that money.

Safe harbor 401(k) plans, however, are not subject to specific IRS nondiscrimination tests, which are described in further detail below. This is the main motivation for creating a safe harbor 401(k). It frees business owners from worrying about whether their plan is in danger of violating the test and potentially running into issues with the IRS.

In exchange, the business owner has to offer a minimum employer match. There are three basic types of matches the employer can offer:

  • Non-Elective: A contribution of 3% to all employees. This goes to every employee, even those who don’t contribute themselves
  • Basic: A dollar-for-dollar match of the first 3% of an employee’s compensation and 50 cents on the dollar for the next 2%.
  • Enhanced: The employer matches 100% of the first 4% of an employee’s contribution.

Employer matches under a safe harbor 401(k) must vest immediately, meaning receiving the money is not contingent on working for the company for a certain period.

What Are the IRS Nondiscrimination Tests?

Most 401(k) plans are subject to an annual test by the IRS that looks at the difference between the highest-paid employees at a company and those who receive less compensation. The purpose of the test is to make sure that executives and other highly paid employees aren’t the only ones at the company who are using the workplace plan.

The test divides employees into highly compensated employees and non-highly compensated employees. In 2024, highly compensated employees are officers who earn at least $225,000 per year (up from $215,000 in 2024), owners holding 5% or more of the company or owners who earn more than $155,000 (up from $150,000 in 2023).

A 401(k) plan must pass both the actual deferral percentage (ADP) test and the actual contribution percentage (ACP) test. To pass, the ACP and ADP of all highly compensated employees must not exceed:

  • the greater of 125% of the ACP and ADP of all non-highly compensated employees
  • the lesser of either:
    • 200% of the ACP and ADP of all non-highly compensated employees
    • 102% of the ACP and ADP of all non-highly compensated employees

Why Companies Use Safe Harbor 401(k) Plans

The IRS is, to be frank, a pain to deal with. The less you have to worry about potentially violating a rule, the better. This is especially true for small business owners who are worried about many other issues. Using a safe harbor 401(k) costs a company a bit in terms of contributions to employee accounts, but it saves it the hassle of dealing with the IRS discrimination tests each year.

Small companies also are more likely to fail the nondiscrimination tests because there aren’t enough non-high compensation employees to make up for the contributions of the high compensation employees. A safe harbor 401(k) is a way to render the test irrelevant if a company knows it’s likely to fail. If a company doesn’t add a safe harbor provision and its plan fails the test, then highly compensated employees would be severely limited in how much they could contribute to their 401(k).

Safe Harbor 401(k) Plans for Employees

For employees, a safe harbor 401(k) plan will generally work no differently than any other 401(k) plan. You put money into your plan as a percentage of your paycheck. It’s then invested in stocks, bonds or mutual funds. You pay taxes when you withdraw your money in retirement.

The only major difference would be if your company chose to automatically deposit 3% of your compensation. If this happens, you’ll have a 401(k) account even if you didn’t choose to participate. This requires nothing from you, though, and you essentially are getting free money. If your employer does the company match option, it works like any other company match, and you’ll have even more money in your account to invest and save for retirement.

Bottom Line

SmartAsset: How Safe Harbor 401(k) Plans Work

A safe harbor 401(k) is a specific type of workplace retirement plan. It allows small business owners to avoid nondiscrimination tests that the IRS subjects most 401(k) plans to. In exchange for avoiding this test, the business must offer a company match to its employees. There are three basic types of matches that employers can offer: non-elective, basic and enhanced. For employees, a safe harbor 401(k) works just like any other 401(k) plan.

Retirement Planning Tips

  • For help with your safe harbor 401(k) account, find a financial advisor could help you create a financial plan to reach your retirement needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Part of your retirement savings plan is knowing how much you’ll need to save to live your best retirement life. Figure out that number – and see if you are on track – with SmartAsset’s free retirement calculator.

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