Small business owners know that finding and keeping good employees is one of the keys to increasing profits. A Safe Harbor 401(k) is a great way to reward employees and keep them happy by making generous retirement contributions on their behalf which are immediately vested. This means the employee can leave a company anytime rather than wait a few years in order to receive 100% of the employer contributions.
It also means that the employer avoids costly plan testing and may allow for much higher contributions for both the owner and highly compensated employees. Non-discrimination testing is one of the largest disadvantages for company owners running a traditional 401(k) plan.
It makes the plan more expensive to operate and may reduce the allowable contributions that can be made by the owner and highly compensated employees.
This required testing is meant to ensure that all employees, regardless of salary or level of income, are treated equally by the plan.
Under testing rules if non-highly compensated employees aren’t putting enough into the plan, then the amount owners and highly compensated employees that can contribute will be limited.
A Safe Harbor 401(k) allows employers to disregard the non-discrimination testing as long as they make a contribution on behalf of their employees.
In order to be considered a Safe Harbor 401(k) the employer must make at least one of two types of contributions on behalf of employees:
- Contribute 3% of every employee’s salary regardless of whether or not they contribute.
- Or provide a 100% match of the first 3% of employees’ contributions and 50% of the next 2% of their contributions.
If this Safe Harbor minimum contribution is satisfied, the employer can then defer the maximum $20,500 or $27,000 for those age 50 or older, into their own 401(k).
Newly established Safe Harbor 401(k)s can also take advantage of a tax credit created by the Secure Act of 2019 that can be as high as $16,500 for starting a new qualified company plan.
The tax credit is equal to $250 for each non-highly compensated employee who is eligible to participate in the plan with a minimum credit of $500 and a maximum credit of $5,000 for three years.
Also, if a business adds an auto-enrollment feature to their plan they can claim a tax credit of $500 per year for three years.
While mandatory contributions to employee 401(k) accounts can be an expensive proposition for a large company, for a small business it may be more cost-effective to make retirement contributions on behalf of employees rather than deal with the more expensive and burdensome non-discrimination testing.
And remember the most important thing the employer may get out of making these employee contributions is keeping good employees happy.
And happy employees tend to stay.
This article is for informational purposes only. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a lawyer, tax or financial professional. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.