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When it comes to saving for retirement, 401(k) plans are a popular choice for both employers and employees. However, not all 401(k) plans are the same. Employers can choose between a traditional 401(k) plan and a Safe Harbor 401(k) plan, each offering unique features and benefits. Whether you're an employer or employee, it's important to understand the differences between these 401(k) plans.
Planning for retirement? A financial advisor can help you chart a path toward your personal and financial goals.
What Is a Safe Harbor 401(k)?
A Safe Harbor 401(k) is a type of retirement savings plan that meets specific Internal Revenue Service (IRS) requirements but allows a company to avoid complex testing requirements by meeting certain contribution and vesting standards. These tests aim to make sure contributions to the plan do not disproportionately favor higher-income employees over lower-income employees.
Safe Harbor plans mandate that employers make contributions to employee accounts in one of the following ways:
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Non-elective contributions: Employers make a fixed contribution (a required 3% minimum of an employee’s compensation) to all eligible employees, regardless of whether employees contribute to the plan themselves.
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Matching contributions: Employers match a percentage of employee contributions, 100% of the first 3% of salary and 50% of the next 2%.
Additionally, Safe Harbor contributions are immediately vested, meaning employees fully own these contributions as soon as the employer makes them. This feature makes Safe Harbor 401(k)s particularly attractive for employees seeking guaranteed employer contributions without the risk of losing funds if they leave the company.
Employers of any size can offer Safe Harbor 401(k) plans.
Safe Harbor 401(k) vs. Traditional 401(k)
The main differences between a Safe Harbor 401(k) and a traditional 401(k) lie in their employer contributions, compliance requirements and benefits for employees. Here's a closer look:
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Employer contributions: While traditional 401(k) plans offer flexibility in employer contributions (which may or may not be provided), Safe Harbor plans require mandatory employer contributions. These contributions can either be non-elective or match a portion of employee contributions.
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Compliance testing: Traditional 401(k) plans are subject to annual nondiscrimination tests, which assess whether contributions disproportionately favor highly compensated employees. Safe Harbor plans, on the other hand, are exempt from these tests if employers meet the required contribution and vesting rules.
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Vesting schedules: Traditional 401(k) plans often include a vesting schedule, meaning employees must work for the company for a certain number of years before they fully own the employer's contributions. In contrast, Safe Harbor contributions are immediately vested, offering greater security for employees.