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When an employer sets up a Safe Harbor 401(k) plan instead of a Traditional 401(k), they create a retirement benefit program with predetermined contribution rules. By adhering to the same rules for all employees, wherever their level is in an organization- entry-level to CEO, these plans automatically can pass nondiscrimination tests (NDTs) or sometimes don’t need to participate in NDTs at all.  NDTs are performed to ensure that 401(k) retirement plans benefit all employees, not just high earners or company owners. By choosing a Safe Harbor 401(k) plan, businesses avoid the costs associated with participating in an NDT that could fail and need to be fixed and the compliance hassles of ongoing maintenance of a conventional 401(k) plan.[1],[2],[3]

Key aspects of Safe Harbor 401(k) plans:

  • Generally, they are a pre-tax investment account, meaning that the money you place in this account is deducted from your check before taxes are collected. However, some plans can be set up to have post-tax contributions or both pre-and post-tax contributions choices. [4]
  • Plans can be set up to match contributions in three ways. 2,[5]
    • Basic– Employee contributions of 3% are 100% matched by employers. If the employee contributes 2% above that, the employer will match those contributions by 50%. To earn a full match, employees must contribute 5% of their income to have a total 4% match.
    • Enhanced– Employee contributions up to 4% are matched 100% by employers. This is a straight dollar per dollar match of employee contribution up to 4%.
    • Nonelective– Employers contribute 3% based on the employee’s salary to every employee’s account whether the employee is contributing or not. These contributions do not involve the employee but are automatically made to the employee’s account from the employer.
  • These matching structures are minimums, an employer could not set up a Safe Harbor 401(k) plan that fell below the Basic or Enhanced matching percentages outlined above, but an employer can increase matching up to 6% of employee contributions if they do so for all employees within the organization. Nonelective contributions could not exceed $58,000 per year, which is the same max contribution limit for combined employee and employer contributions for Traditional or Roth 401(k) plans. 2,[6]
  • You are 100% vested whenever the employer deposits contributions into your account. Unlike other 401(k) plans, vesting happens when the funds hit your account, not on a vesting schedule based on years of employment. 4
  • For 2022, yearly contribution limits for employees are $20,500 for people younger than 50 and an extra $6,500 catch-up amount for 50 and older. Contributions are made from January to December of that year. 4,[7]
  • With all investment accounts, you expose some or all your invested money to loss for the chance to earn a higher profit. Investment gains hinge on an ongoing and long-term investment strategy that uses your risk tolerance and diversification to mitigate some risks. Even with these in place, you are exposing your money to loss.[8]
  • There are no income limits to participate in; because these plans have a set matching structure, they don’t have the income limits that traditional 401(k) plans have.[9]
  • Employers must allow all employees to participate if they are 21 and above, have one year of service, and have 1000 hours per year. Employers can build plans that expand these perimeters to include more employees but never narrow them. 4
  • To comply with the safe harbor requirements, employers must provide rights and obligations of the employee under the plan and how an employee can contribute to their account each year to all eligible employees. This reach-out needs to happen at least 30 days before the plan’s year begins, but not more than 90 days before. 2
  • Fees vary from plan to plan. It is crucial to understand how much you are paying in fees.
  • If you leave an employer, you can take your money with you. In addition, you can rollover these account to non-Safe Harbor plans if it matches the tax designation of the original account. [10]
  • The earliest you can make penalty-free withdrawals is 59 ½, and the penalty is an extra 10% on top of the taxes collected. However, there are some exemptions to the early withdrawal penalty- if you are permanently and totally disabled, if you lose your job at 55 or older, if you have medical expenses that exceed 10% of your modified adjusted gross income, with some divorce settlement types and if you die. 4
  • Required Minimum Distributions (RDMs) need to start at 72, but you can still contribute to this type of plan if you are still employed. With some plans, that contribution offsets the RMDs. [11]
  • You can take a low-interest loan on 401(k) accounts, up to $50,000 or 50% of your account balance. Still, you will have to pay it back sometimes within 90 days but definitely within five years (this period may be extended if the money is used to buy a primary home) or at leaving that job, or it becomes taxable income. The payments will most likely be held back from your paycheck. Some plans don’t let you contribute to your account until the loan is paid back. Interest charges go directly back into your retirement account. 4,[12]

If you want to explore investment accounts for your business, Scarlet Oak Financial Services can be reached at 800.871.1219 or contact us here.















Advisory services offered through Capital Asset Advisory Services, LLC, a Registered Investment Advisor. This material has been prepared for informational purposes.