Key takeaways

• Under a traditional safe harbor 401(k), employees are immediately vested in company contributions.

• Employers can avoid yearly nondiscrimination testing by following safe harbor rules.

• Companies can choose to provide contributions in which the employee can collect funds without needing to defer any of their own.

Using a safe harbor 401(k) arrangement can lower operational burdens for employers and bring clarity to workers’ retirement savings.

Workplace 401(k) plans can have different setups and share a common goal: to enable people to make progress on their retirement savings. Compared to a traditional 401(k), another type called a safe harbor 401(k) can simplify managing a savings plan, which can benefit both workers and their companies.

Empower findings reveal that Americans think they need at least $1 million to retire, and two in five people (42%) prefer that employers automatically opt workers into a retirement savings plan like a 401(k). Having employers contribute to retirement savings accounts is also a high priority for more than four in five Americans (46%), according to another Empower study. The demand rises even more for higher-income earners: The percentage jumps to 53% among people with household incomes of $100K or more.

Here’s how safe harbor 401(k) plans can supercharge both those retirement savings wants — and still meet a company’s needs.

The basics of a safe harbor 401(k)

A safe harbor 401(k) resembles a traditional 401(k) plan and offers additional benefits: It gives workers ways to streamline contribution rules, and employers can simplify operations. If a company can meet certain requirements, it’s able to avoid the overhead, rules, and costs associated with yearly nondiscrimination tests that are typical of other 401(k) plans.¹

Safe harbor 401(k) plans require a fixed employer contribution. That mandatory subsidy is akin to an employer match, also commonly known as “free money” to the worker. Employees can also benefit from favorable requirements around vesting, or when they are allowed to own the contributions outright.²

Employer contribution options

Safe harbor 401(k) plans come in three types, and the employer must choose one of these options in order for it to be considered a legal safe harbor plan.³ The difference is how each path approaches safe harbor 401(k) matching.

• Basic match: Employer provides a company match of 100% on the first 3% of an employee’s deferred income, along with a 50% match of the next 2% of deferred income.

• Enhanced match: Employer provides a company match that’s as generous (or even more so) than the basic formula’s tiers. For example, an employer could match 100% of an employee’s first 4% of elective deferrals.

• Nonelective contribution: Employer provides a flat-rate percentage to all employees, regardless of whether an employee contributes their own funds. So, it’s truly a “contribution” rather than a “match” — an employer could contribute 3% to all eligible employees under this setup, even if an employee has no election.

All of these contributions must be immediately vested for employees. For example, if they subsequently stop working at the company, they are able to fully own those funds rather than needing to wait a certain time frame.

Under safe harbor 401(k) plans, there’s also an add-on approach known as Qualified Automatic Contribution Arrangement, or QACA. Under this setup, the wider administrative requirements for safe harbor 401(k) plans apply, with some differences.⁴

A worker’s contributions are established as a specific percentage of annual salary, and that allotment increases each year (unless they opt-out themselves). The employer would then apply its matching contribution based on that amount:⁵

• The company gives a non-elective contribution (as outlined above)

• Or the QACA match must be at minimum: 100% of an employee's contribution up to 1% of compensation and a 50% matching contribution for the employee's contributions above 1% of compensation and up to 6% of compensation.

Vesting rules are slightly different for QACA — under the requirements, the company must have the employee be 100% vested in the company’s contributions by the time they hit two years of service (instead of immediately under other safe harbor plans).⁶

Read more: What percentage should I contribute to my 401(k)?

Safe harbor vs. traditional 401(k)

Determining if a safe harbor 401(k) is a better fit than a traditional 401(k) plan can come down to the compliance requirements, especially for companies with smaller teams and less bandwidth for plan management.

Safe harbor 401(k) plans are not required to undergo annual nondiscrimination testing that’s necessary for traditional 401(k) plans. The yearly testing compares the contribution amounts for non-highly compensated employees (NHCE) and highly compensated employees (HCE) — such as company owners and managers — to ensure they’re proportional and equitable.⁷

There’s a tradeoff in avoiding the annual testing — employers must give employees in safe harbor plans a certain level of company contributions, and employees vest immediately in employer contributions.⁸

Eligibility and requirements

Safe harbor plans can be used by companies of any size, as long as they follow specific guidelines set out by the IRS. These can include how to communicate the plan and its changes to eligible employees.⁹

On the worker’s side, safe harbor 401(k) rules are similar to those of traditional plans. The same annual IRS contribution limits apply – including for pre-tax, Roth, post-tax and catch-up contributions.¹⁰ Immediate vesting can make transitioning workplaces easier, while receiving yearly notices can keep saving for retirement top-of-mind for workers on a regular basis.

Read more: How much should I save for retirement?

Benefits of a safe harbor 401(k)

Both workers and companies can benefit from the streamlined rules and regulations that apply to safe harbor 401(k) plans. This setup allows employers to:

• Avoid IRS penalties: If a traditional 401(k) plan fails to meet the requirements of each year’s nondiscrimination testing and does not make corrections in a timely manner, the company’s plan could lose its tax-qualified status and potentially pay taxes on excess contributions.¹¹ Following the rules of a safe harbor 401(k) avoids this testing altogether.

• Unlock higher contribution potential for highly compensated employees: Since safe harbor 401(k) plans have strict contribution percentages across employees — and employers don’t need to compare the savings of different tiers of workers — there’s higher upside for HCEs who make more income on an annual basis to increase their retirement savings contributions.

• Simplify plan administration: Safe harbor 401(k)s allow employees to be vested in their company contributions immediately, removing the staff and operational overhead to manage vesting schedules. There’s also less complexity, given the absence of yearly nondiscrimination testing.

Read more: Top benefits of a 401(k) plan

Considerations for safe harbor 401(k) plans

Documentation can be a factor for companies considering a safe harbor 401(k) plan. The IRS requires employers to follow a specific process to give eligible employees written notice of their rights and obligations under the plan.

The notice must go into detail about which safe harbor method is being used, how employees can elect contributions, and if other workplace plans or criteria apply. Companies must also take timing into account: Employees who qualify for the plan must receive the notification at least 30 days but not more than 90 days before the start of the plan year. For workers who become eligible after the cutoff date, additional rules apply.¹²

A safe harbor 401(k) also brings an element of commitment: Because these notices cover a full plan year, employers must also consider that they’re locking themselves into safe harbor rules for at least one year.

Is a safe harbor 401(k) the right fit?

A safe harbor 401(k) plan can serve small businesses and those with a large amount of high earners. Companies that are able to follow the specific flows needed to comply with IRS requirements get the advantage of avoiding yearly nondiscrimination testing.

When it comes to retirement income, more than half of Americans (55%) plan to or currently rely on personal savings and investments  — such as 401(k) plans and IRAs — according to Empower research. Getting a safe harbor plan in place can ease the process, possibly increasing workers’ participation and keep retirement savings goals on track.

FAQs about safe harbor 401(k)s

Do I need to file IRS forms for a safe harbor plan?

Workers may not see much of a difference in how the plan is established, though employers will need to follow specific guidelines on how to disclose the plan to eligible employees along with the IRS.

How much can I contribute to a safe harbor 401(k)?

A safe harbor 401(k) follows the same annual contribution limits determined each year by the IRS.

What happens if I don’t meet safe harbor requirements?

IRS penalties can apply, which can include losing tax-exempt status for the retirement savings plan.