Considering a Safe Harbor 401(k) Plan? Here’s What to Know

When small to midsize businesses decide to sponsor a qualified retirement plan, they often face one big challenge — complex administrative requirements. As a business owner, you already have plenty of responsibilities and IRS-mandated testing for traditional 401(k) plans can add time, cost, and frustration.

Fortunately, there is an alternative. A safe harbor 401(k) plan is designed to simplify administration while allowing highly compensated employees to contribute the maximum allowable amount. But before you move forward, it’s important to understand how these plans work and their trade-offs.

A Simpler Approach

Traditional 401(k) plans are required to undergo annual nondiscrimination testing to ensure that highly compensated employees (HCEs) do not receive disproportionate benefits compared to other employees. These assessments include the Actual Deferral Percentage (ADP) test and the Actual Contribution Percentage (ACP) test.

If a plan fails either test, the business may need to refund contributions to HCEs or make additional contributions to other employees creating extra costs and administrative burdens.

Safe harbor 401(k) plans address this issue by requiring specific mandatory employer contributions. In return, the IRS waives the ADP and ACP testing requirements. As a result, plans are not subject to nondiscrimination testing, and highly compensated employees (HCEs) may contribute up to the annual limit.

For 2025, an HCE generally includes anyone who owns more than 5% of the company or earns more than $160,000 (indexed annually for inflation).

Key Requirements

To qualify for safe harbor status, employers must make one of the following contributions to each eligible employee’s account:

• A nonelective contribution of at least 3% of compensation for all eligible employees, or

• A matching contribution, such as 100% of the first 3% of deferred compensation plus 50% of the next 2%.

Timing is also critical. To establish a safe harbor 401(k) for 2025, employers must complete all setup paperwork and provide written notice to employees by October 1, 2025, with contributions starting no later than November 1, 2025.

The IRS requires that the employee notice clearly describe both the plan’s features and the employer’s contribution obligations.

Potential Drawbacks

Safe harbor plans require employers to make mandatory contributions that are immediately and fully vested. After the contributions are made, employees retain ownership of these funds, regardless of their employment status with the company.

Cutting or pausing contributions is challenging and may cause IRS issues unless exceptions exist. This can be risky for businesses with irregular cash flow.

 

The Bottom Line

Safe harbor 401(k) plans are designed to simplify administration and provide employee benefits; however, they may not suit every organization. Businesses that can accommodate the required contributions may benefit from a plan that enables both employers and employees to save for retirement while avoiding annual testing requirements.

If you’re considering one, we can help you evaluate whether a safe harbor 401(k) aligns with your company’s financial goals and resources.