A safe harbor 401(k) requires the company to contribute to employees’ accounts every year. In return, the plan skips the yearly ADP test, which compares what higher-paid employees save with what everyone else saves, and can skip the ACP test too if its match stays within IRS limits. A traditional 401(k) makes company contributions optional, and the plan has to pass the ADP test every year, plus the ACP test if it matches.
The safe harbor contribution belongs to employees as soon as it’s deposited. The exception is the automatic enrollment version, called a QACA, which can require up to two years of service first. A traditional plan can use a vesting schedule.
A 401(k) established on or after December 29, 2022, has to automatically enroll eligible employees, whether it’s traditional or safe harbor, unless an exception applies. Exceptions include businesses in existence less than three years and employers that normally employ 10 or fewer employees.
A calendar-year traditional plan can switch to safe harbor as late as November 30 with a 3% flat contribution, or even after the year ends with a 4% flat contribution.
A 401(k) can be set up as a traditional plan or a safe harbor plan, and the choice is a trade. A traditional plan leaves company contributions up to the company, and in exchange the plan has to pass yearly IRS tests that compare what goes into the plan for higher-paid employees with what goes in for everyone else.
A safe harbor plan skips those tests, and a plan that matches has to keep its match within IRS limits to skip the second one. In exchange, the company has to contribute to employees’ accounts every year.
Here’s what a failed test looks like.
An owner contributes to the 401(k) all year. After the year closes, the plan fails because the owner and other higher-paid employees contributed too much compared with everyone else. One way to fix it is to return part of the owner’s contributions, and that money is taxable to the owner in the year it’s paid out. A safe harbor plan doesn’t run that test, so that outcome doesn’t come up.
The trade runs the other way too. In a safe harbor plan, employees own the safe harbor contribution as soon as it’s deposited, except in the automatic enrollment version. A traditional plan can make them wait.
The checklist below asks 12 yes-or-no questions about your owners, your budget, and your employees, and shows whether a traditional or a safe harbor design fits your company better.
Featured Checklist
Is a Safe Harbor Right For Your Plan?
Twelve questions to answer before you set your 401(k) design for next plan year.
What Is the Difference Between a Traditional and a Safe Harbor 401(k)?
Both plans let employees contribute part of their pay through payroll deductions. The difference is what the company has to put in and whether the plan has to pass yearly IRS tests.
Traditional 401(k) vs. Safe Harbor 401(k)
Feature
Traditional 401(k)
Safe harbor 401(k)
Eligibility
Set by the plan document. The plan can't require more than one year of service to join.
Same rule.
Company contributions
Optional. The company can match, contribute for everyone, do both, or contribute nothing.
Required. 3% of pay for each eligible employee who isn't highly compensated, or a match covering every dollar an employee contributes up to 3% of pay and half of each dollar on the next 2%, or an enhanced match. A QACA can use a smaller match. All three are described in the next section.
Vesting
Company contributions can follow a vesting schedule.
Employees own the safe harbor contribution as soon as it's deposited, though a QACA can require up to two years of service. Any other company contribution can follow a vesting schedule.
Yearly IRS tests
The plan has to pass the ADP test every year, plus the ACP test if it has a match.
ADP test not required. The ACP test can also be skipped when the match stays within the limits in the FAQs.
Top-heavy rules
Apply. A top-heavy plan may have to make minimum company contributions for certain employees.
Exempt in any year the plan makes no other company contributions.
Automatic enrollment
Required for plans established on or after December 29, 2022, unless an exception applies.
Same rule.
The yearly tests are called the ADP and ACP tests. They compare the share of pay that goes into the plan for highly compensated employees with the share for everyone else. Highly compensated employees include anyone who owns more than 5% of the company. As the other employees save more, the rules let highly compensated employees save more.
When a traditional plan fails, the company has to correct the failure, and one way is returning contributions to highly compensated employees. The plan’s test results are worth a look before the year closes, so they belong with the compliance items your committee checks each quarter.
How Does a Safe Harbor 401(k) Work?
The company picks one of two contributions:
A flat 3% of pay for every eligible employee who isn’t highly compensated, whether or not the employee puts in anything.
A match of every dollar an employee contributes up to 3% of pay, plus half of each dollar on the next 2%. For an employee contributing 5% of pay, that comes to 4%. A more generous match works too, within the limits in the FAQs.
Either choice comes with the same three rules:
The money is the employee’s right away. No vesting schedule, with one exception for the automatic enrollment version below.
Everyone eligible who isn’t highly compensated gets it. The company can’t limit the contribution to employees still on the payroll on the last day of the year.
The design is set before the year starts and stays in place for the year. New plans and the flat contribution have later deadlines, covered below.
One more applies to a plan that matches: employees get a notice each year, and sending it 30 to 90 days before the plan year starts meets the deadline. Confirm who sends it, whether that’s the plan’s administrator or another provider.
A plan that meets the safe harbor rules doesn’t run the ADP test. Skipping the ACP test takes a few more limits on the match, listed in the FAQs.
The automatic enrollment version. A QACA, or qualified automatic contribution arrangement, is a safe harbor plan that signs employees up for them. The plan starts taking a set percentage of pay from everyone eligible, and employees can opt out or pick a different amount. That’s what automatic plan design means. A QACA can use the same flat 3%, or a smaller match of every dollar up to 1% of pay and half of each dollar on the next 5%, which maxes out at 3.5% of pay. It’s also the one safe harbor version that can make employees work up to two years before they own that contribution.
Does a 401(k) Have to Use Automatic Enrollment?
It depends on when the plan was established. A 401(k) established on or after December 29, 2022, whether traditional or safe harbor, has to automatically enroll eligible employees. The default starts at 3% to 10% of pay. The rate goes up 1 percentage point a year until it reaches at least 10%, and it can’t go above 15%. Employees can opt out or choose a different rate. The requirement doesn’t make the company contribute anything.
The requirement doesn’t apply to:
401(k) plans established before December 29, 2022.
Businesses in existence less than three years.
Employers that normally employ 10 or fewer employees.
SIMPLE 401(k) plans, church plans, and governmental plans.
How Much Does a Safe Harbor 401(k) Cost an Employer?
The cost depends on which contribution the plan uses. The flat contribution goes out whether or not employees contribute. The match goes only to employees who contribute.
Picture a company whose eligible employees who aren’t highly compensated earn $1,000,000 in combined pay.
Flat contribution: 3% of that pay is $30,000, whether or not any employee contributes.
Match: The most the basic match can be is 4% of pay. If every one of those employees contributes at least 5% of pay, the match costs $40,000. If only the employees earning half of that pay contribute at least 5%, and the rest contribute nothing, the match costs $20,000.
Run the same math on your own payroll and last year’s contribution rates.
What Are the Pros and Cons of a Safe Harbor 401(k)?
The pros:
Owners can contribute up to the yearly limit. No ADP test means no refunds to owners and other highly compensated employees. The ACP test goes away too when the match stays within the limits in the FAQs. Cutting or stopping the contribution mid-year brings the ADP test back for that year.
No top-heavy contribution. In any year the plan makes no other company contributions, it’s exempt from the top-heavy rules.
Employees get money in their accounts. Everyone eligible who isn’t highly compensated gets the flat contribution, or earns the match by contributing.
The cons:
The company is locked in for the year. The contribution has to be made, and it can be cut or stopped mid-year only under the conditions in the FAQs below.
No vesting schedule to hold employees. They own the safe harbor contribution right away. Only a QACA can make them wait, up to two years.
Employees who quit mid-year still get it. The contribution can’t be limited to people still on the payroll at year-end.
A match adds a yearly notice to every eligible employee.
How Do You Choose Between a Traditional and a Safe Harbor 401(k)?
Moving to a safe harbor design is a way to avoid failing the yearly tests. Four questions show what each design would change for your company:
Have owners or other highly compensated employees had contributions returned because the plan failed its tests? A safe harbor plan skips the ADP test, and can skip the ACP test when its match stays within the limits in the FAQs.
Is the plan top-heavy? A plan is generally top-heavy when the account balances of its key employees are more than 60% of all the account balances in the plan, and a top-heavy plan may have to make minimum company contributions for certain employees. A safe harbor plan is exempt from those rules in any year it makes no other company contributions. Your plan’s administrator can tell you who counts as a key employee.
Can the company make the required contribution every year? In a traditional plan, company contributions are optional. In a safe harbor plan, the company can reduce or stop contributions mid-year only under the conditions in the FAQs below.
Does the company want employees to stay a set time before they own company contributions? A traditional plan can require that. Among safe harbor plans, only a QACA can, and only up to two years.
Answer these with your plan’s administrator before choosing.
What Are the Safe Harbor 401(k) Deadlines?
These dates are for a plan that runs on the calendar year:
New plan: A new safe harbor plan’s first plan year generally has to run for a minimum of 3 months, so it has to start by October 1.
Match in an existing plan: Must be adopted before the plan year starts, with the notice out 30 to 90 days ahead.
Flat contribution of 3%: Must be added by November 30.
Flat contribution of 4%: Can be added as late as December 30 of the following year.
What to Ask Before You Choose
Put these questions to your plan’s administrator:
Did the plan pass its yearly tests in each of the last three years, and if not, how was each failure corrected?
Is the plan top-heavy today?
What would each safe harbor contribution have cost last year, using our actual payroll and contribution rates?
Was our plan established before December 29, 2022, and does the automatic enrollment requirement apply to it?
When does the safe harbor notice need to go out for next plan year?
If we switch, what happens to company contributions already made under our current vesting schedule?
Bring these questions and the one-page summary at the end of this post to your next conversation with your administrator.
Before Your Next Plan Year
A safe harbor 401(k) requires a company contribution and skips the ADP test. A traditional 401(k) keeps company contributions optional and has to pass the yearly tests. Run the cost of each option before the deadlines above pass.
Download Traditional vs. Safe Harbor at a Glance to keep the rules and deadlines on one page. To review your plan’s design with First Hill Trust, schedule a brief plan design review.
Featured Guide
Traditional Vs. Safe harbor at a Glance
What each 401(k) design requires, what it costs, and when to act
Two apply to a more generous match. It has to give each employee at least as much as the standard formula at every contribution level, and its match rate can't rise as employees contribute more. One applies to any safe harbor match: a highly compensated employee can't get a higher match rate than an employee who isn't highly compensated and contributes the same percentage of pay. Two more apply if the plan also wants to skip the ACP test: no match on employee contributions above 6% of pay, and any discretionary match capped at 4% of pay.
Only if the company is operating at an economic loss for the year, or its safe harbor notice told employees in advance that contributions could be reduced or stopped. Employees have to get a new notice at least 30 days before the change takes effect, and a reasonable chance to change what they're contributing first. The plan then has to pass the ADP test for the whole year, and the ACP test too if it matches.
No. The required contribution is for eligible employees who aren't highly compensated.
Yes. A safe harbor plan can include other company contributions, such as profit sharing. In any year it does, the plan loses its exemption from the top-heavy rules, and the profit sharing contribution has to pass its own nondiscrimination test.
No. The yearly limit on what an employee can contribute is the same in both plans. The difference is that in a safe harbor plan, highly compensated employees don't face refunds from a failed ADP test.
Internal Revenue Service, 401(k) Plan Fix-It Guide: 401(k) Plan Overview
Internal Revenue Service, 401(k) Plan Fix-It Guide: The Plan Failed the 401(k) ADP and ACP Nondiscrimination Tests
Internal Revenue Service, Mid-Year Changes to Safe Harbor 401(k) Plans and Notices
Code of Federal Regulations, 26 CFR 1.401(k)-3, Safe Harbor Requirements
Code of Federal Regulations, 26 CFR 1.401(m)-3, Safe Harbor Requirements
Federal Register, Automatic Enrollment Requirements Under Section 414A (proposed regulations)
Important Disclosures
First Hill Trust Company is a Washington State-chartered trust company. Investment advisory services are provided by BAC Capital Advisors, an SEC-registered investment adviser and a wholly owned subsidiary of First Hill Trust Company. Registration does not imply a certain level of skill or training. This article is educational. Neither First Hill Trust Company nor BAC Capital Advisors is acting as ERISA counsel or tax counsel to any plan or plan sponsor, and nothing here replaces advice from qualified counsel about your own plan.
Accuracy and currency. Statutory provisions and regulatory descriptions in this article were checked against the cited primary sources as of the date of publication, but First Hill Trust Company and BAC Capital Advisors make no representation or warranty as to the accuracy, completeness, or timeliness of the information, and accept no liability for actions taken in reliance on it. Regulations and guidance change. Confirm current requirements with qualified counsel.
Educational purpose only. Provided by First Hill Trust Company for general informational and educational purposes only. It is not legal, tax, accounting, investment, or fiduciary advice, does not constitute a recommendation regarding any plan, investment, strategy, or course of action, and does not consider any recipient’s specific circumstances. Consult your own qualified advisors before acting.
No offer, agreement, or commitment. Nothing in this material constitutes an offer, solicitation, agreement, or commitment to provide any particular service or to assume any particular responsibility. Descriptions of what a trustee, administrator, adviser, committee, employer, or other party “may” or “can” do are illustrative of how such arrangements commonly work and do not describe the terms of any specific engagement. The actual services provided, the allocation of responsibilities, the scope of any delegation, and the duties of any party are governed solely by the applicable plan documents, trust agreement, advisory agreement, and written service agreements. In the event of any inconsistency, those documents control.
Services and regulatory status. First Hill Trust Company and its affiliates offer retirement plan services, recordkeeping and administrative services, trust and fiduciary services, investment advisory services, and group benefits services, in each case subject to applicable regulatory requirements and the terms of the relevant agreements. Not all services are offered to all clients, in all states, or in all circumstances. Investment advisory services are offered through an affiliated investment adviser; a copy of its Form ADV Part 2A is available upon request. Insurance and group benefits products are offered through appropriately licensed entities. The availability and scope of any service depend on eligibility and the applicable agreements.
Fiduciary status under ERISA. Fiduciary status under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), is determined based on the functions performed and the authority exercised, not on titles or labels. Whether any particular party is acting as a fiduciary, and the scope of any related duties or potential liability, depends on the facts and circumstances specific to the plan and the relationship. Engaging a trustee, adviser, or other service provider does not eliminate a plan sponsor’s or committee’s own fiduciary responsibilities, including the duties to prudently select and monitor any party to whom responsibilities are delegated.
Affiliated entities and conflicts of interest. First Hill Trust Company is affiliated with other entities, including an affiliated investment adviser and entities providing administrative, trust, or other services. These relationships may create conflicts of interest, including where an affiliate is engaged or compensated in connection with a plan. Such conflicts and compensation are described in the applicable service agreements and the affiliated adviser’s Form ADV Part 2A; fiduciaries should consider them when evaluating any engagement.
Statutory and regulatory references. References to ERISA, the Internal Revenue Code, and related statutory or regulatory provisions are general summaries only. They are not a substitute for review of the actual statutory text, regulations, or guidance from the Department of Labor, Internal Revenue Service, or other relevant authorities, and they do not address how those provisions may apply to any particular plan, sponsor, fiduciary, or individual. Laws, regulations, and guidance are subject to change and to interpretation by the relevant agencies and courts. Examples, categories, and situations described are simplified for illustration and may not reflect the requirements or circumstances of any particular plan or person.
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