Safe Harbor 401(k)

Fenwick Joinery 401(k) plan keeps failing its nondiscrimination testing because rank-and-file participation is low, and every spring the owners receive corrective refunds of their own deferrals. The plan adviser suggests converting to a SAFE HARBOR design. The essential trade-off is that:

1. A.The required employer contribution may be placed on a six-year graded vesting schedule like any other matchSafe harbor contributions must be immediately and fully vested; that is a defining condition of the design.
2. B.The plan becomes exempt from ERISA fiduciary requirements altogetherFiduciary duties of prudence and loyalty continue to apply in full. Only the nondiscrimination testing is relieved.
3. C.Highly compensated employees may defer unlimited amounts, because the elective deferral limit does not apply to safe harbor plansThe statutory elective deferral limit still applies. What disappears is the risk of corrective refunds from failed testing.
4. D.The employer must make a prescribed matching or non-elective contribution for non-highly-compensated employees that is immediately 100% vested, and in return the plan is deemed to satisfy the ADP and ACP testsCorrect. Guaranteed, immediately vested employer money in exchange for automatic testing relief.

Why: A safe harbor 401(k) buys relief from the ADP and ACP nondiscrimination tests by requiring the employer to make a specified contribution for non-highly-compensated employees, either a prescribed matching formula or a non-elective contribution to all eligible employees regardless of whether they defer. That required contribution must be immediately and fully vested. In exchange, highly compensated employees may defer up to the statutory elective deferral limit without the risk of corrective refunds.

Halverson Foods' 401(k) fails its annual nondiscrimination testing year after year because too few rank-and-file employees defer, forcing refunds to the executives. The plan's adviser recommends converting it to a SAFE HARBOR 401(k). What does Halverson give up in exchange for skipping the testing?

1. A.It must lengthen its vesting schedule on employer contributions from three years to six years.Wrong - this is backwards. Safe harbor contributions must vest IMMEDIATELY, not more slowly.
2. B.It must make a required employer contribution - either a match or a nonelective contribution - that is 100 percent vested immediately.Correct. Guaranteed, immediately vested employer money is the price of skipping the ADP/ACP tests.
3. C.It must exclude all highly compensated employees from participating in the plan.Wrong. Excluding the executives would defeat the purpose. Safe harbor design lets them participate fully.
4. D.It must cap every participant's elective deferrals at half the normal annual limit.Wrong. Safe harbor status does not reduce anyone's deferral limit; it exists so that highly compensated employees can defer the FULL limit without corrective refunds.

Why: A safe harbor 401(k) buys its way out of the ADP/ACP nondiscrimination tests by guaranteeing every eligible employee a meaningful employer contribution. The sponsor commits in advance to either a matching formula or a nonelective contribution for all eligible employees, and - the point candidates forget - those safe harbor contributions must be 100 percent vested IMMEDIATELY. There is no graded or cliff schedule on them. Highly compensated employees may then defer the full statutory limit without fear of a corrective refund.