The Advantages Of A Safe Harbor 401(k) (And Why Your Employer Offers One)

One of the benefits of employment is being able to participate in an employer-sponsored retirement plan, but while not every company offers one (and not every employee is eligible to participate in one), companies that do have choices in what types of plans to offer. One of the popular options is a safe harbor 401(k), a plan very similar to a traditional 401(k) with the exception that the employer is required to make contributions, and those contributions must be fully vested, according to the Internal Revenue Service (IRS). This differs from a traditional 401(k) which allows the employer to opt out of making those contributions and instead leave funding the account fully up to the employee, and an employee must remain at their job for a certain length of time in order to receive the full amount of the employer's matching contributions.

There are additional differences noted below, but it is important to know that the goal of these plans, is to ensure that more Americans are preparing for retirement rather than helping individuals who are already highly compensated by their employers qualify for additional tax breaks. With pensions having gone by the wayside, participating in an employer-sponsored retirement plan is an extremely valuable component of anyone's long term retirement planning.

Safe harbor 401(k) plans are a pretty sweet deal for employers, and they are great options for smaller companies and companies that employ a large number of seasonal or part-time employees. However, according to the Internal Revenue Service (IRS), they can be adopted by companies of any size and can be combined with other retirement plans. Employers who choose to offer this type of plan usually do so because it provides benefits for both the employer and the employee and allows them to attract and retain quality employees.

With this option, the employer is relieved of the responsibility of nondiscrimination compliance testing that the federal government requires of employers offering traditional 401(k) plans. If you don't know what these annual tests are, chances are you aren't alone, as they are something the employer offering a traditional 401(k) retirement plan has to worry about and not something the employee would typically have any knowledge of.

There are actually three types of nondiscrimination testing for employers offering traditional 401(k) plans. According to Betterment, an online financial advisory company, these three types of tests are the Actual Deferral Percentage Test (ADP), the Actual Contribution Percentage Test (ACP), and the Top-Heavy Test. These tests are designed to ensure that a company's higher-earning employees are not benefiting from the planning disproportionately to the lower-earning employees, but they are costly, complicated, and time-consuming for the employer to conduct each year.

Like a traditional 401(k) plan, safe harbor plans are great for employees to gradually build a retirement fund without having to put much thought or effort into it. Both plans allow you to contribute pre-tax dollars to your retirement plan, but the added bonus with this option is that employees can still benefit from it even if they don't contribute themselves from their paycheck.

With safe harbor plans requiring employee contributions to be fully vested at the time they are deposited into the account, the employee has full control over the funds. This means that the employee gets to take the account's full value with them when they leave the company, whether they resign, retire, or are terminated. With a traditional 401(k), the contributions made by your employer throughout the year may not be available to you until you have worked a certain number of years or a certain number of hours for the year.

According to the U.S. Department of Labor, an employee participating in a safe harbor 401(k) plan can have their contributions equally matched up to 3%, and matched $.50 on the dollar between 3% and 5%. With these types of contribution matches, you will be well on your way to building a successful retirement fund.