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Safe Harbor vs. Traditional 401(k): Key Differences

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What is the difference between a Safe Harbor 401(k) and a Traditional 401(k)?

A Safe Harbor 401(k) requires mandatory employer contributions that immediately vest, allowing for automatic Internal Revenue Service (“IRS”) non-discrimination testing compliance.

A Traditional 401(k) allows flexible employer contributions but requires annual non-discrimination testing.

Why does non-discrimination testing matter for Traditional 401(k) plans?

Non-discrimination testing helps to ensure  highly compensated employees (“HCE”s) do not benefit disproportionately over non-highly compensated employees (“NHCE”s).

This testing includes three key tests:

  • ADP Test (Actual Deferral Percentage) – Compares salary deferrals between HCEs and NHCEs.
  • ACP Test (Actual Contribution Percentage) – Evaluates employer matching contributions across employee groups.
  • Top-Heavy Test – Determines if key employees hold more than 60% of total plan assets.

Failure may require refunds to HCEs or additional contributions for NHCEs.

What are the employer contribution requirements for a Safe Harbor 401(k)?

Employers must select one of the following:

  • Basic Match – 100% match on the first 3% of employee contributions + 50% match on the next 2%.
  • Enhanced Match – 100% match on up to 4% of employee contributions.
  • Nonelective Contribution – At least 3% of salary for all eligible employees, regardless of their participation.

All contributions vest immediately.

When is a Safe Harbor 401(k) a better choice?

A Safe Harbor plan may be preferable if:

  • The company has few NHCEs, increasing the risk of failing nondiscrimination tests.
  • The company previously failed testing and wants to avoid corrective actions.
  • The employer prefers simplified administration without annual testing.

What are the drawbacks of a Safe Harbor 401(k)?

  • Higher employer costs due to required contributions.
  • No vesting schedules for employer contributions—employees own them immediately.

What are the key deadlines for Safe Harbor 401(k) plans?

  • New plans: Must be established by October 1 for a calendar-year plan.
  • Existing plans: Amendments to add a Safe Harbor provision are typically effective January 1, with a 30-day employee notice required.