If a potential plan sponsor is considering implementing a 401(k) plan for employees, or changing the plan provided, the choice is to either offer a traditional 401(k) or look to alternative options using the safe harbor provision.
This can be a complicated decision, as it combines both laws and regulations surrounding plan offerings as well as your businesses priorities.
They should also consider employee preferences since the plan is part of the benefits that can facilitate attraction and retention of the top talent they want to recruit.
The ADP/ACP Test
One of the first details to consider is whether the plan currently offered, or potentially offered, fails the Actual Deferred Percentage (ADP) and Actual Contributed Percentage (ACP) tests. The organization probably has some executives that count as highly compensated employees (HCEs), either because:
- They own more than 5% of the business in the prior or current year, or
- Their compensation is in excess of $120,000 (for 2018; $125,000 for 2019) (the employer can limit the number of employees treated as HCEs under the compensation portion of the test to the top-paid 20% of employees).
The ADP test stipulates that a 401k plan cannot significantly advantage HCEs, meaning that HCEs aren’t deferring more than the formula outlined below.
Similarly, the ACP test uses the same formula for matching and voluntary contributions. This formula is:
- 125% of the non-HCE average, or
- The lesser of:
- 200% of the non-HCE average, or
- The non-HCE average + 2%.
The Top-Heavy Test
Similar to the ADP/ACP tests, the goal of the top-heavy test is to ensure a 401k plan is balanced among and benefiting all employees.
In this test, the account balance of key employees (calculated slightly differently from HCEs) cannot exceed 60% of total plan assets.
Businesses can implement matching or profit-sharing programs to offset the plan if this becomes a problem.
Choosing a Safe Harbor Plan
If the business is looking at safe harbor plans, it’s usually because it has failed one of the two tests outlined above.
The safe harbor plan design facilitates the maximization of 401(k) plan savings, but these safe harbor plans may not always be the best fit, or offer the organization necessary flexibility in plan design.
Safe harbor plans have different requirements in regards to plan eligibility, employer contributions, matching, and profit sharing.
There are also some situations where either ADP/ACP or top-heavy testing is still required. Safe harbor plans also have participant disclosure requirements.
Which plan makes the most sense for a business may well depend on its compensation structure and the type of benefits it wants to offer top employees.
For businesses where the highest earners and key personnel have significantly larger compensation and want to take maximum advantages of a 401(k), a safe harbor plan, even with less flexibility, may be the best option.
Anne Tyler Hall is the owner and principal attorney of Hall Benefits Law. HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.
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