Why Business Owners Should Preserve Their 401(k) Safe Harbor
The last few years have been extremely challenging for business owners. Whether it was the pandemic shockwaves that closed doors, figuring out how to keep workers productive during the work from home (WFH) transition, bumpy supply chain issues, lack of qualified talent and now the rise of “quiet quitting,” it’s been tough. Now we are faced with an uncertain economic forecast that seems to change daily.
As we approach the deadlines to affirm Safe Harbor for 2022 and provide required notices to employees for 2023, our clients are asking a lot of really important questions around what elements of their Qualified Plans are discretionary or flexible. Most specifically, many clients are asking “Do I really need Safe Harbor?”
In uncertain times and with an unpredictable economic horizon, it is important to ask those questions and evaluate all expenses and liabilities in your business.
However, for most of our clients, Safe Harbor provisions not only reflect a generous benefit in a competitive labor market but represent a crucial compliance component for their 401(k) Profit Sharing Plan. A Safe Harbor allows owners and highly compensated employees the ability to maximize their 401(k) contributions and provides important employer contribution functionality for match, profit sharing or in conjunction with their Cash Balance Defined Benefit Plan.
With 2023 401(k) limits at an all-time high, more Highly Compensated Employees in plans and many 401(k) Profit Sharing Plans running “Top Heavy”, your plan’s Safe Harbor features may be more important than ever!
Leveraging your retirement plan
First, your workplace retirement plan is flexible. You can always change the design to fit your business needs. However, like anything, there are rules to follow. To begin, let’s talk about best case scenarios, traditional workplace arrangements and why they were set up that way. Then we’ll share ways you can modify your plan and other creative funding arrangements that may bridge the current economic period to a more prosperous tomorrow.
What is a Safe Harbor 401(k)?
A Safe Harbor plan design is the most common 401(k) plan design for small business owners. It allows owners and highly compensated employees to max out their 401(k) accounts regardless of participation by the rank and file employees. It requires that employers contribute either 3% of salary to all eligible employees as a Non-Elective contribution or match employee contributions up to 4% of salary.
By doing this, the 401(k) Plan avoids top heavy testing and annual non-discrimination testing; both tests are cumbersome and costly in the small and mid market. Failure puts owners on the hook to fund employee accounts (usually around 3%) or give back money through corrective distributions. There are additional administrative costs for top heavy and non-discrimination testing too.
Can we keep the Safe Harbor and reserve cash?
One idea to keep the Safe Harbor provision yet reserve cash on hand is to amend when you deposit funds. For example, many employers follow a payroll cycle on both the 3% Non-Elective and Safe Harbor Match. Each payroll, they fund the Safe Harbor. But, instead, you could wait to deposit those funds until the year end or tax filing deadline with an extension. For the 3% Non-Elective Solution that would not require an amendment, but to change the match frequency may require a formal Plan Amendment.
It’s important to note that employee deferrals must always be deposited as soon as possible. They are employee funds and not assets of the company, so each payroll period, the employee portion must be deposited into their account.
But, as for the employer funded Safe Harbor, yes, you have some flexibility as to when you deposit it. This could free up cash on hand till a later day in the future and when business is steadier.
Discretionary means “maybe”
Just because you did a discretionary match and profit sharing contribution in addition to your Safe Harbor contribution last year doesn’t mean you have to do it this year. Often when we run plan design illustrations for owners, we include scenarios that focus on the maximum tax advantages for owners and key staff to optimize wealth accumulation and corporate tax deduction. The goal is to show possibilities and how a robust retirement plan can help you prepare for retirement and reward your most talented employees.
But that’s just it, they are hypothetical illustrations. Yes, they are possible, and they do work. Yet, if times are uncertain and you need flexibility, that’s the beauty of working with CrossPlans. We bake it into the plan.
Additional layers of Discretionary matching and profit sharing beyond Safe Harbor contributions are always your choice. As a best practice, you’ll want to talk with your team and tell them that this year is different from years past. And chances are if your team is dialed in, they won’t be surprised. That’s another benefit to the term, Profit Sharing. When there is profit, it is shared. And when owners need to make tough decisions, it is discretionary.
Change when, who and how employees can join the plan
With a booming economy, employers use benefits, like the 401(k), to recruit top candidates. But what happens now with, tighter cash management policies, hiring freezes and softening economy? One idea is for employers to still use benefits as a recruiting tool but change when, who and how employees earn access to them. This way companies are only rewarding loyal talent.
Of course, there are eligibility rules. If you want to talk about your plan and how to change when, who and how employees can enter the plan, contact us for a specific conversation and we will tailor the plan to your workforce.
Another strategy that we are discussing with clients in both the 3% Non-Elective and Safe Harbor Match environment for 2023 is exploring only allocating Safe Harbor contributions to Non-Highly Compensated Employees. This strategy can reduce the liability of the Employer Contribution while protecting the right for Owners and Highly Compensated Employees to maximize their personal 401(k) contributions. If you would like to talk about this or any other strategies to amend your plan, please contact us: we are here to help.
Calling it quits on the Safe Harbor may create more problems than it solves
If you really want to amend your plan and remove the Safe Harbor provision, it can be done prospectively or mid-year, however we need to have a conversation to discuss your Plan’s Top Heavy status and ADP Testing position. Removing Safe Harbor may dramatically reduce or completely erase the ability for the owners to make 401(k) contributions to the Plan without triggering Top Heavy minimum contributions.
It is important to remember that CrossPlans generally deploys the “Maybe” or “wait and see” approach to the 3% Non-Elective Safe Harbor which does give us more flexibility, but there are very important strategies around Owner contributions to discuss with your CrossPlans consultant around the timing of owner contributions if we are going to push the 2023 “maybe” election out to December 1, 2023.
To remove your Safe Harbor Match for the next calendar year, the notice must be sent to eligible employees by December 1st for a January 1st start date.
To do it mid-year, you will need to send a 30-day notice to all eligible employees. Then after the notice period, the plan is no longer required to match Safe Harbor contributions, but you must match through the end of the Safe Harbor period and then subject the plan to the previously discussed Non-Discrimination and compliance testing.
Rainbow after the storm
With every economic storm, there is always a rainbow at the end. It’s the pioneering spirit that got you into business – and keeps you in it. We’ll get you through this. If you need to make changes to your plan, of course, we’re here to help. And, if you want to discuss ideas on how to shift liabilities to the future, we have options for that too.
Offering a Safe Harbor retirement plan allows you to defer taxes and freely save for your own future. It helps your top employees fund their retirement. By preserving Safe Harbor, you are not required to conduct plan testing, which avoids surprise penalty payments to employees and awkward conversations with key employees while also optimizing employer contribution options if the winds change in your favor. Other ideas to reduce company costs include adjusting when deposits are withdrawn, modifying discretionary funds and changing eligibility requirements.
When you partner with an expert TPA like CrossPlans, we can help you evaluate each of these options and help you determine which is best for you, your company and your workforce. Contact us today to learn more.
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