401(k) Plans

Employees, Sponsors Sailing Toward Safe Harbor

Safe harbor plans can help employers avoid the tricky shoals of nondiscrimination testing.

The name itself certainly sounds enticing: “safe harbor 401(k) plan.” How can such a gingerly named plan possibly be anything but good? Indeed, for employers and employees alike, there’s much to like.

Safe harbor plans have been around for 10 years, but sponsor interest has gathered steam only in the last few years after the usual wait-and-see period.

Like all 401(k)s, a safe harbor 401(k) plan allows eligible employees to contribute a portion of their own salary to a retirement plan. Employers contribute either matching or non-elective amounts to the plan on behalf of eligible employees. Employer contributions are tax-deductible and employee contributions are excluded from income for federal income tax purposes.

Highly Compensated Benefits

But while the 401(k) is one of the most popular retirement plans, nondiscrimination requirements often limit the amount highly compensated employees (HCE) can contribute on their own behalf. Safe harbor provisions allow employees to maximize their 401(k) contributions while automatically satisfying actual deferral percentage (ADP) and actual contribution percentage (ACP) nondiscrimination testing rules as long as certain requirements are met.

To satisfy the ADP and ACP testing requirements, your organization has to: 1) make contributions for your employees and 2) eliminate all vesting requirements placed on those contributions.

The employer contribution requirement provides you with two options. If you choose the first option, you must make a matching contribution for each non-highly compensated employee (NHCE) who elects to contribute to the plan. The basic matching formula is 100 percent for at least the first three percent of employee compensation and 50 percent on the employee’s own contributions above three percent, but not to exceed five percent of compensation. Such matching contributions automatically satisfy the actual contribution percentage test.

Alternatively, you can design an enhanced matching formula so long as the rate is non-increasing and the aggregate amount of the match at least equals the basic matching formula (e.g., 100 percent match on deferrals up to four percent of compensation).

If you choose the second option, you must make a flat, non-elective contribution for each NHCE who is eligible to participate in the plan, even if the employee opts not to contribute. The non-elective contribution must equal three percent of the employee’s compensation for the year.

In either employer contribution option, you can make similar contributions for highly compensated employees, as long as the match percent for any HCE is no greater than the match percent for any NHCE at the same rate of deferral.

You will enjoy greater administrative ease with a safe harbor plan. These plans minimize testing and you can save a lot of administrative time, effort and aggravation by not having to refund money to highly compensated workers if discrimination tests fail.

Keep in mind, however, that you are responsible for administering the plan and keeping records. Also, the company must make non-elective contributions regardless of its financial situation. If you decide to halt contributions, you must provide 30 days’ notice to your employees and you will need to pay for standard discrimination testing.

Another requirement of the safe harbor 401(k) plan is that any employer contribution, either matching or non-elective, is fully vested to the employee. And therein lies a major drawback of safe harbor; you lose an employee retention incentive.

IRS Stipulations

If you’re sold on the idea, the Internal Revenue Service (IRS) requires you to provide written notice to employees of the company’s intent to implement a safe harbor 401(k) plan. The notice must be sent out at least 30 days and not more than 90 days prior to the beginning of the plan year. In addition, the notice must include specific information as stipulated by the IRS.

If you are contemplating the safe harbor 401(k), we can help you carefully analyze the potential increase in expenses attributable to the employer contribution requirement. In some instances, your desire to make a full contribution may outweigh the increase in expenses. However, everything depends on such factors as overall plan participation, the size of your company and whether or not you are already making any matching contributions or non-elective contributions under an existing plan.

We also recommend that you consider automatic enrollment for new employees as they become eligible. Automatic contributions make it easier for participants to save more for retirement. Advise employees, however, that if they select this feature they will have their deferral percentage automatically adjusted to increase their contributions to the plan over time. Employees wishing to not participate need to fill out a waiver form to stop the automatic contributions.

The key to a successful 401(k) enrollment with or without automatic enrollment or safe harbor provisions is good communication to your employees. For more information about 401(k)s please contact us.

San Francisco Paid Sick Leave

As of February 5, 2007 all employers must provide paid sick leave to each employee who performs work in San Francisco. For every 30 hours worked, an employee accrues one hour of paid sick leave.

Employees working for small employers (fewer than 10 employees) are allowed to accrue up to 40 hours of paid sick leave. Part-time and temporary employees count towards the 10-employee figure. Employees of larger employers can accrue up to 72 hours.

Employees are entitled to paid sick leave for their own medical care and also to aid or care for a family member or designated person.

Resources:

SF Sick Leave Hotline: (415) 554-6271 Website: www.sfgov.org/olse