Safe-harbor 401(k) plans escape annual tests

Safe harbor 401(k)

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Small-business retirement plans

Safe harbor 401(k)

The employer, by meeting the contribution standards of a safe-harbor 401(k) plan, doesn’t have to worry about annual nondiscrimination testing for employer contributions. That’s largely because employer contributions are mandatory in a safe-harbor 401(k) plan. The employer can make either matching or nonelective contributions under a safe-harbor plan.

In the former scenario, the employer can match each eligible employee’s contribution, dollar for dollar, up to 3 percent of the employee’s compensation, and 50 cents on the dollar for the employee’s contribution that exceeds 3 percent (up to 5 percent maximum) of the employee’s compensation. The alternative is for the employer to make a nonelective contribution equal to 3 percent of compensation to each eligible employee’s account.

The employer has to make either the matching contributions or the nonelective contributions every year. The safe-harbor 401(k) plan document will specify which type of contribution will be made, and the employee has to receive this information before the beginning of each year. This plan can allow additional catch-up contributions in the amount of $5,500 (in 2012) for employees ages 50 and over. The plan can also be designed to allow plan loans, which allow employees to borrow against their plan balances.