Many ESOP companies either make or have considered making a safe harbor matching or discretionary contribution in their ESOP or 401(k) plan. As the year-end approaches, now is a good time to revisit the safe harbor contribution rules.
Why make a safe harbor contribution?
If the highly compensated employees (HCEs) at your company are limited in the amount they can defer in the 401(k) plan due to the IRC Section 401(k) ADP and/or IRC Section 401(m) ACP nondiscrimination testing requirements, then a safe harbor contribution may be a good fit for your company.
If you make a safe harbor contribution then you are deemed to satisfy the 401(k) and matching nondiscrimination testing requirements. This will allow HCEs to be able to maximize their 401(k) deferrals.
In addition to automatically passing the testing, you may reduce your 401(k) compliance testing expenses by not having to perform ADP/ACP discrimination testing.
Safe harbor contributions are also useful for plans that have top-heavy issues because the safe harbor contribution can be used to satisfy the top-heavy contributions requirements.
How do I make a safe harbor contribution?
Generally a safe harbor contribution can be satisfied in many ways, most commonly with a 3% nonelective contribution, a 4% matching contribution, or a Qualified Automatic Contribution Arrangement (QACA).
Can I make a safe harbor contribution to the ESOP?
You are allowed to make the safe harbor contribution in the ESOP. This means that you can designate contributions that you would have otherwise made (e.g., loan payments) as safe harbor contributions, enabling you to make the safe harbor contribution in the form of stock with no additional cash outlay. If you are not leveraged, you could make the contribution directly in the form of shares, again with no cash outlay.
What are the safe harbor timing requirements?
In order to satisfy the safe harbor requirements, an annual safe harbor notice must be provided to the participants. The notice must be provided between 30 and 90 days before the first day of the plan year, and employees who become eligible after the notice period must receive the notice by their date of eligibility.
» December 1 is the safe harbor notice deadline for most plans with a December plan year-end.
Why wouldn’t a company make a safe harbor contribution?
I am often told this is too good to be true and asked why all companies wouldn't do this. The biggest reason is that companies are not aware of this planning alternative. The downside to this approach is that the safe harbor contributions will generally need to be 100% vested and that all participants are eligible for the safe harbor contribution (even if they are not eligible for the ESOP), though there are some planning techniques to minimize this impact.
The IRS website has more information on the safe harbor rules:
Safe harbor 401(k) plans
A safe harbor 401(k) plan is similar to a traditional 401(k) plan, but, among other things, it must provide for employer contributions that are fully vested when made. These contributions may be employer matching contributions, limited to employees who defer, or employer contributions made on behalf of all eligible employees, regardless of whether they make elective deferrals. The safe harbor 401(k) plan is not subject to the complex annual nondiscrimination tests that apply to traditional 401(k) plans.
Safe harbor 401(k) plans that do not provide any additional contributions in a year are exempted from the top-heavy rules of section 416 of the Internal Revenue Code.
Employers sponsoring safe harbor 401(k) plans must satisfy certain notice requirements. The notice requirements are satisfied if each eligible employee for the plan year is given written notice of the employee's rights and obligations under the plan and the notice satisfies the content and timing requirements.
In order to satisfy the content requirement, the notice must describe the safe harbor method in use, how eligible employees make elections, any other plans involved, etc. Income Tax Regulations section 1.401(k)-3(d)(2), contains information on satisfying the content requirement using electronic media and referencing the plan's Summary Plan Description.
The timing requirement requires that the employer must provide notice within a reasonable period before each plan year. This requirement is deemed to be satisfied if the notice is provided to each eligible employee at least 30 days and not more than 90 days before the beginning of each plan year. There are special rules for employees who become eligible after the 90th day. See Income Tax Regulations section 1.401(k)-3(d)(3).
Both the traditional and safe harbor plans are for employers of any size and can be combined with other retirement plans.