We can all agree that a traditional 401(k) plan is a good way to start saving for retirement, even during the years when saving is the last thing you want to worry about. But what is a Safe Harbor Plan and why should you choose it for your business?
A Safe Harbor Plan generally allows all participants to save more money for retirement because it lets an employer offer a retirement plan that benefits all eligible employees regardless of salary.
Non-Safe Harbor Plans are subject to a variety of nondiscrimination requirements intended to ensure the plans do not unduly favor highly compensated individuals such as executives and business owners (those who earned over $120,000 in 2015). In these plans, highly compensated individuals are limited to defer only about 2% more than the average of all the employees who are not highly compensated. This means that in Non-Safe Harbor Plans, business owners are not capitalizing the full potential of a 401(k) because they are reducing their own accounts by the limitations associated with the nondiscrimination requirements.
On the other hand, because a Safe Harbor Plan fulfills select IRS requirements, a business owner can contribute the maximum deferral ($18,000 for 2015 or $24,000 if age 50+) regardless of other employee contributions without the fear of a refund for failing to meet the nondiscrimination requirements.
This table illustrates the difference a Safe Harbor Plan can make by bypassing the nondiscrimination tests to allow business owners and employees alike to save for retirement.
In the scenario presented, the business owner maximizes his deferral without having to worry about a refund.
Less tax regulation on your company’s 401(k) is always a simpler and cheaper choice for small employers. A Safe Harbor Plan may also be the right choice for large employers with substantial differences in pay between hourly employees and executives. Big or small, a Safe Harbor Plan may be the right choice for you.