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What Is a Safe Harbor 401(k) Plan and When Should You Invest?

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An employer going over their safe harbor 401(k) with their employee.

The Safe Harbor 401(k) is a type of retirement plan designed to provide employers with a simple way to bypass annual nondiscrimination testing. This testing is a complex process that ensures contributions to retirement plans do not heavily favor highly compensated employees, and is required by traditional 401(k) plans. Understanding the Safe Harbor 401(k) plan, its benefits and how it compares to other retirement savings options can greatly influence your financial planning and retirement investment strategy.

Consider working with a financial advisor to help you determine the right retirement accounts for you.

How a Safe Harbor 401(k) Works

The Safe Harbor 401(k) plan operates uniquely when compared with 401(k) accounts. Employers are required to make mandatory contributions to their employees’ accounts, which are immediately 100% vested. This means employees have full ownership of these contributions without any waiting period.

These contributions can either be in the form of non-elective contributions, full contributions irrespective of the employee’s contribution, or matching contributions that are directly proportional to the employees’ investments. For 2024, the contribution limit for employees in a Safe Harbor 401(k) is $23,000 (up from $22,500 in 2023), with an additional $7,500 for those aged 50 or older.

Employers can contribute at least 3% of the employee’s salary regardless of the employee’s contribution with non-elective contributions. For basic matching, employers must match 100% of employee contributions up to 3% of their salary and 50% of contributions between 3% and 5% of salary. Enhanced matching has to be at least basic matching, but can be more. This significantly higher matching limit, compared to other retirement plans, gives employees more money towards their retirement.

Benefits of a Safe Harbor 401(k)

An employer reviewing their safe harbor 401(k) plan.

There are several advantages to the Safe Harbor 401(k) plan that make it an attractive option for employees and employers alike.

These include immediate vesting of employer contributions, bypassing annual nondiscrimination tests and higher employer contribution limits.

A Safe Harbor 401(k) can also be a tax-saving strategy as employee contributions are made pre-tax, thereby lowering the individual’s taxable income for the year.

Moreover, earnings on the investments are tax-deferred until withdrawal, providing substantial tax advantages.

An early-career professional, contributing the maximum amount to a Safe Harbor 401(k) alongside a 3% employer match could potentially accumulate substantial retirement savings by 65, assuming a consistent approach with regular contributions and the advantages of compound interest over time.

When a Company Might Choose a Safe Harbor 401(k)

A Safe Harbor 401(k) is a good choice for a small business with high-earning employees who want to contribute the maximum amount to their retirement accounts but are limited due to failing nondiscrimination testing.

This plan ensures all employees, regardless of their income level, can potentially contribute a significant amount to their retirement savings.

Several factors might influence a company’s decision to opt for a Safe Harbor 401(k), including the company’s size, the income levels of employees and the desire to maximize contributions to high earners’ retirement accounts.

Therefore, companies need to evaluate these factors carefully, potentially involving financial advisors, before deciding on a Safe Harbor 401(k).

Alternatives to a Safe Harbor 401(k)

While the Safe Harbor 401(k) offers numerous benefits, it’s essential to consider other retirement savings options. Here are four of the most popular:

Notably, a Safe Harbor 401(k) has mandatory employer contributions and avoids nondiscrimination testing.

SIMPLE 401(k) plans also require employer contributions but have lower contribution limits, while SEP IRAs and Roth IRAs might offer more flexibility for individual contributors.

You may want to consider working with a financial advisor to get help in determining which option is best for you.

Bottom Line

An employer thinking about their safe harbor 401(k) plan.

The Safe Harbor 401(k) plan offers numerous benefits, including immediate vesting of employer contributions, higher contribution limits and tax-saving advantages. However, it may not be the best fit for every company or individual. Companies should note the composition and retirement goals of their workforce to support an informed decision on the adoption of a Safe Harbor 401(k). Individuals should consider their retirement savings goals, tax situation and job stability before deciding whether a Safe Harbor 401(k) is a good fit for their retirement goals.

Tips for Retirement Savings

  • A financial advisor can help you find the right balance of retirement accounts that can help you achieve your long-term financial goals. They can also help you determine if you’re saving enough for your own individual retirement. 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.
  • A retirement calculator can be a great tool to help you estimate if you’re saving enough money to reach your financial goals.

Photo credit: ©iStock.com/filadendron, ©iStock.com/svetikd, ©iStock.com/Kateryna Onyshchuk

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