The Safe Harbor 401(k) Plan allows eligible employees to contribute a portion of their own salary to a retirement plan. Employers contribute either matching or non-elective amounts to the plan on behalf of eligible employees. Employer contributions are tax deductible and employee contributions are excluded from income for Federal Income Tax purposes.
- Sole proprietorships, partnerships, limited liability corporations (LLCs), or incorporated businesses, including subchapter S corporations, may establish a 401(k) plan.
- All eligible employees must be allowed to participate in the 401(k). An eligible employee is any employee who:
. is at least 21 years old
. has performed one (1) year of service and worked 1,000 hours in the year beginning with the date of hire.
- Union employees and non-resident aliens who have no U.S source of income may generally be excluded from coverage.
- Employer contributions are tax deductible for the employer — up to 25% of compensation of all eligible participants.
- Employee elective deferrals are excluded from the employee’s income for Federal Income Tax purposes.
- Tax-deferred growth potential is possible — any investment earnings grow tax-deferred until withdrawn.
- The base formula is 100% of elective deferrals up to 3% of compensation and then 50% of elective deferrals on the next 2% of compensation. Matching contributions may not be made with respect to an employee’s elective deferrals in excess of 6% of the participant’s compensation.
- The employer may elect the non-elective formula (minimum of 3%) of all eligible participants’ compensation. Under this formula, all eligible employees would receive this non-elective contribution whether making salary reduction contributions or not.
A discretionary contribution may also be made to the plan, subject to deductibility limits (25% of all eligible participants’ compensation less the total amount of “safe harbor” contributions).
- The safe harbor 401(k) plan does not require extensive discrimination testing. It is important to note that there is market risk involved when investing in mutual funds, including possible loss of principal.
Attractive benefits for employees
- Offering a 401(k) plan can make it easier to attract and retain valuable employees.
- A 401(k) plan can assist in providing retirement income for eligible employees.
- Employees may contribute toward the retirement benefits offered by the employer.
- Automatic enrollment enables new employees to automatically be placed into the plan as soon as they are eligible.
- Automatic contribution increases make it easier for participants to save more for retirement. Employers who select this feature must adjust the employee deferral percentage annually.
- Designated Roth Contributions are allowed in Safe Harbor 401(k) Plans.
Early Withdrawal Penalty
Generally, a 10% tax penalty is applicable to distributions for participants under age 59 1/2. Participants may have to pay Federal Income Tax on the distributions, as well.
Reporting and Disclosure Requirements
- Reporting to the IRS — Form 5500 (Annual Return/Report of Employee Benefit Plan) and applicable schedules must be filed with the IRS each year.
- Disclosure to Plan Participants and Beneficiaries — each plan participant or beneficiary should receive an easily understandable summary plan description within 90 days after they become eligible and a summary annual report each year within 7 months after the end of each plan year.
Note: An employer can establish less restrictive eligibility requirements than the ones listed above, but not more restrictive ones.
Vesting is the participant’s ownership in the value of his/her retirement account or benefit. All employee and employer Safe Harbor matching or non-elective contributions are 100% vested immediately. The employer may elect to use a graded vesting schedule for discretionary contributions. All employee contributions are 100% vested immediately.
Generally, the deadline to establish a new plan is anytime between January 1 and October 1 of the applicable year.
The employer may elect a matching contribution formula or a non-elective formula of eligible employee compensation to satisfy IRS “safe harbor” requirements. If a matching formula is elected: