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Safe Harbor

Many employers have sponsored a 401(k) plan and were excited to maximize their personal contributions into the plan only to find they had to reduce their annual contribution because the plan failed to meet the nondiscrimination tests which are required to ensure that the non-highly compensated employees (NHCEs) are benefitting from the plan fairly in comparison to the owners or highly compensated employees (HCEs). This can be a frustrating situation and can be remedied in a couple of ways.

First, the employer can implement a communication and education campaign to better explain the benefits of participation and contribution to all employees with primary goal of getting more NHCEs to participate and those who are participating to contribute more each pay period. Alternatively, the employer could modify their plan to include a “Safe Harbor” plan provision. 

Beginning January 1, 1999, employers are not required to perform nondiscrimination testing if their plan design meets certain employer contribution requirements called Safe Harbor provisions. To qualify for this exemption, the employer must make one (but not both) of the following two contributions:
 
  1. Matching Formula – The employer is required to provide to each non-highly compensated employee a 100 percent match on salary deferrals up to 3 percent of compensation and a 50 percent match on salary deferrals between 3 and 5 percent of compensation. This results in a total match of 4 percent of compensation if the employee contributes 5 percent of their pay into the plan. This contribution must be fully vested (meaning the employee is entitled to 100% of their account balance—including the employer match balance—when they leave the plan). 
  2. Non-Elective Contribution – The employer is required to provide non-highly compensated employees a contribution of 3 percent of their compensation. This contribution must also be fully vested.  
Upon satisfying the above requirements, owners and highly compensated employees are able to defer up to $17,500 in the 2014 calendar year. If the plan participant is age 50 or older he or she is able to defer an additional $5,500 (called a “Catch-up Contribution). 

In this type of plan, the benefits of not having to pay for the added expense of nondiscrimination testing may offset the required employer contributions.