If you’re a small business owner interested in starting a 401(k) plan for your employees, you already understand how they will benefit, but you should also understand how the plan will affect you. Sometimes, the traditional 401(k) plan doesn’t end up providing you the full benefit you’d hoped for. Here’s why this happens, and what you may elect to do instead.

The Problem With Traditional 401(k) Plans

A traditional 401(k) plan limits business owners, company officers, and high wage earners, often referred to as highly compensated employees (HCEs) in how much money they can contribute to the plan. That limit is based on two things:

  • ADP and ACP testing: These special non-discrimination rules ensure that deferrals made by HCEs are not disproportionate to deferrals made by non-HCEs.
  • Top-heavy testing: This rule prevents plan assets of key employees to be comprised of 60% or more of the total assets in the plan. Key employees are defined as employees who own more than 5% of the business, their spouses, and lineal relatives, as well as certain shareholders and company officers.

Oftentimes, owners try to stash away the maximum amount allowable per year, unaware they may be over-contributing to the plan. In many cases, they get a refund for excess contributions, because as a general rule, highly compensated employees can’t contribute more than 2% of the average of all other employees who are eligible to participate.

Looking for a clear, thorough guide to the entire payroll process for small businesses? Download The Small Business Guide To Payroll

An Example:

Imagine your company has 11 people who are eligible to contribute to a 401(k) plan. Of those 11 people, only one is considered highly compensated. Of the remaining 10, only 5 contribute to a traditional 401(k) plan. Of those 5 employees, each contributes 4%. Thus, the average of those 10 eligible employees is 2% of the entire group. The 5 employees are considered non-participating because they are eligible to participate and don’t; their non-participation brings down the average.

Under the ADP and ACP testing rules, the highly-compensated employee can contribute only 4%, which is based on the average of the non-HCE group rate, plus an additional 2%. Everything above that is returned to them as compensation—and it is taxed. This is a source of frustration to highly compensated individuals, because they can’t max out their contributions, thus lessening their ability to reach their investment goals with their 401(k) plans.

Processing payroll doesn’t have to be complicated or expensive—but if you’re doing it the wrong way, it can be both. Learn how to avoid these mistakes in this free guide.

The Solution: Implement The Safe Harbor Plan

What is the safe harbor plan?

According to the IRS, 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 Plan Requirements:

  • A required match or noncontributory election. With a safe harbor 401(k) vs. traditional 401(k), any employer contribution is vested immediately at 100%.
  • A required January 1 election. Employers that currently have a traditional 401(k) plan and would like to amend the plan to a safe harbor 401(k), may only implement this change at the start of a new calendar year.

Safe Harbor 401(k) and Traditional 401(k) Plans: A Comparison

As with most tax-sheltered savings plans, the features you choose can trigger certain rules that impact the overall goals you are looking to achieve. Below are the simplified rules for both traditional and safe harbor plan designs. Keep in mind that selecting features outside of these parameters may be possible, but selecting alternate features may prevent you from maximizing the benefits of a safe harbor plan.

  Traditional 401(k) Safe Harbor 401(k)
Testing – ADP/ACP Required Not required
Participant Disclosure Not required but recommended Required at least 30 days prior to implementation and annually thereafter.
Eligibility Flexible. Employers can choose a wait period and entry age of their choice capped at one year of service / 1,000 hours worked and 21 years of age. Not flexible. The eligibility requirements for the employer contribution must match the employee contribution requirements.
Employer contributions Not required Safe harbor can be achieved in several ways:


  • Employer dollar-for-dollar match on the first 4% of the employee’s elected salary deferral.
  • Employer dollar-for-dollar match on the first 3% of the employee’s elected salary deferral and a 50% match on the next 2% of the employee’s elected salary deferral. (4% total match when the employee defers at least 5% into the plan).
  • Employer dollar-for-dollar match on the first 1% of the employee’s elected salary deferral and a 50% match on the next 5% of the employee’s elected salary deferral. (3.5% total match when the employee defers at least 6% into the plan).*
  • Employer non-elective contribution of 3%, regardless of employee contributions into the plan.
Vesting Flexible. There is considerable flexibility up to a six-year graded vesting schedule. Required. Safe harbor contributions require 100% immediate vesting.


*QACA contributions do allow for a 2-year-cliff vesting schedule.

Testing – Top Heavy Required Not required

The SECURE Act of 2019 is the most impactful retirement plan reform legislation in over a decade. Among the many changes in legislation with this act, its provisions provide for more flexibility in adopting safe harbor plan designs.

Under the current law, the safe harbor provision must be in place for the full plan year and must be adopted as of the first day of the plan year. The SECURE Act made a change to this rule to allow for Safe Harbor Nonelective contributions to be added to existing plans mid-year as long as the plan amendment is adopted by the 30th day before the close of the plan year, and a 3% or greater contribution is provided retroactively for the full year.

The new rule also allows for the amendment to be adopted after the 30th day before the close of the plan year if a 4% or greater contribution is provided retroactively for the full plan year. This rule is in effect for plan years after December 31, 2019, and does not apply to Safe Harbor matching contributions.

Benefits Of A Safe Harbor 401(k)

Managing complicated 401(k) plans the wrong way puts small business owners and leaders at a huge disadvantage. A safe harbor 401(k) is a sensible way to go if you can afford to contribute to your employees’ 401(k). This will allow you to safely maximize your own contributions to the plan without the worry of over-contributing to the plan. Along with that comes the added benefit of investing in the retirement future of your valuable employees.

Understanding whether or not a safe harbor 401(k) plan is right for your company is exactly what we’re here for. Helping employers avoid surprises like this is part of the service package we offer at Genesis HR Solutions.

Pick up the phone and give us a call at (781) 272-4900 or contact us online. Our experts are equipped to help you understand the decisions you’re facing and plan for your company’s growth in the long term.