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Safe Harbor 401(k)Starting in 1999 a new twist on the traditional 401(k) plan is available for plan sponsors, the "Safe Harbor 401(k) Plan". This twist on the traditional 401(k) plan promises to be a simpler plan to administer. If an employer adopted this type of 401(k) plan there would be no need to worry about the ADP/ACP testing at the end of each year, and; in some cases, no need to make Top Heavy contributions. All this in exchange for a commitment to make a minimum level of contributions that many sponsors make anyway. The plan must make a contribution to all non-highly compensated employees who are eligible to participate in the 401(k) plan. This contribution must be 3% of compensation and must be fully vested. This contribution may also be used to satisfy the Top Heavy minimum contribution requirement. The contribution may be made to another plan as long as the other plan satisfies the necessary eligibility and vesting requirements for the safe-harbor contribution. Alternatively, the employer may elect to make matching contributions to non-highly compensated employees equal to 100% of the first 3% of employee contributions, plus 50% of the next 2% of employee contributions. The matching contributions also need to be fully vested. The matching contributions can not be used to satisfy the top heavy minimum requirement. With both of these alternatives the contributions are subject to the same restrictions on distributions as are 401(k) deferrals (i.e. they may not be distributed prior to the participants termination, age 591/2, hardship, or death). There is also a safe harbor for the matching contributions that, if satisfied, would eliminate the need to test matching contributions. In order to satisfy the requirements for the safe harbor, (1) the employer must not match deferrals which exceed 6% of the employees compensation; (2) the rate of match must not increase as deferrals increase (i.e. you can not have a formula such as 50% up to 3% and 100% of the next 3%); and (3) matching contributions can not be available to HCEs at a higher rate than are available to Non-Highly compensated employees at any rate of deferral. In order for a plan to take advantage of these "Safe-Harbors" there are two requirements that must be met. First, the plan document must be amended to reflect this intent. The deadline for including this amendment in a plan that wants to use the Safe Harbor option in 1999 is December 31, 1999. Second, the employer must provide notice to the employees at least 30 days before, but not more than 90 days before the beginning of each plan year. For plans that will be using the Safe-Harbor in 1999, the IRS has extended the deadline for the notice to March 1, 1999. The notice must inform the employee of : 1. the contribution formula that will be used, 2. any other potential contributions under the plan, any other conditions for the contributions, 3. the plan to which the contributions are to be made, 4. the method for making elections, and 5. the withdrawal and vesting provisions applicable to the contributions. After analyzing several cases, we have found that the greatest drawback to the safe harbor plan is the requirement that all of the employer contributions be 100% vested. In most cases, over an extended period of time, employers recover a significant amount of the matching contribution due to employee turnover before being fully vested. In cases where the employer is already providing a generous match, and employee turnover is low, the safe harbor plan may be worth considering. Small employers with low turnover who already must provide a 3% top heavy minimum, may also want to consider the safe harbor plan if they have problems passing the ADP tests. | |
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Information is provided for review and consideration only. Please consult legal and tax advisors for practical advice pertaining to your business and personal situations. This page was last updated on Wednesday, January 02, 2008 11:23 AM |
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