Timing Requirements for Including a Safe Harbor Contribution Provision in a New or Existing 401(k) Plan

Jun 1, 2023

By: Scott M. Cloud, MBA, CPC

Including a safe harbor contribution provision in a 401(k) plan gives the plan an exemption to the actual deferral percentage (ADP) test that might otherwise limit the salary deferral contribution amounts of owners, family members of owners, and employees with gross annual wages of $135,000(*) or more (collectively referred to as highly compensated employees or “HCEs”).  In a safe harbor 401(k) plan, HCEs are therefore able to maximize their salary deferral contributions at the IRS limit (**) without any possibility of an ADP testing failure resulting in “corrective taxable refunds”.

* Anyone who had gross wages above $135,000 in 2022 is an HCE in 2023, and anyone with gross wages above $150,000 in 2023 will be an HCE in 2024

** In 2023 the salary deferral contribution limit is $22,500 for those under age 50 and is $30,000 for those age 50 or older

Following is a description of the timing requirements for including a safe harbor contribution feature in a brand new 401(k) plan or adding a safe harbor contribution feature to an existing 401(k) plan:

For a Brand New 401(k) Plan

First, it should be noted that for a brand new 401(k) plan to include a safe harbor contribution provision in its initial year, employees must be able to make 401(k) salary deferral contributions for at least the final three months of the year (i.e., starting no later than the first payroll of October for a calendar year plan).  Provided a new plan has been set up to enable employees to make 401(k) salary deferral contributions starting no later than the first payroll in October, the following timing requirements apply for a plan to be “safe harbor” in its initial year:

  • If the safe harbor contribution provision is adopted no later than October 1st (and employee salary deferral contributions are permitted starting no later than the first payroll date in October):
    • The safe harbor contribution is only required to be funded on compensation paid during the period October 1st through December 31st, and
    • The safe harbor contribution method can be either 3% nonelective or 4% match for the initial plan year
  • If the safe harbor contribution provision is adopted after October 1st but before December 2nd (and employee salary deferral contributions were permitted starting no later than the first payroll date in October):
    • Only the safe harbor nonelective contribution method can be used for the initial plan year, and
    • The safe harbor nonelective contribution must be equal to at least 3% of eligible employees’ plan compensation during the initial plan year
  • If the safe harbor contribution provision is adopted on December 2ndor later (and employee salary deferral contributions were permitted starting no later than the first payroll date in October):
    • Only the safe harbor nonelective contribution method can be used for the initial plan year,
    • The safe harbor nonelective contribution must be equal to at least 4% of eligible employees’ plan compensation during the initial plan year, and
    • A plan amendment adding the safe harbor contribution provision for the initial plan year wouldn’t need to be adopted until the end of the following plan year.  The plan sponsor could therefore choose to adopt the plan without a safe harbor contribution provision, then wait to see if the plan passes the ADP test for the plan’s initial year and – if the plan fails the ADP test – the plan sponsor could elect to amend the plan retroactively to make it safe harbor for its initial year (with a 4% safe harbor nonelective contribution on eligible employees’ plan compensation during the initial plan year).

For an Existing 401(k) Plan

Assuming a calendar plan year, the following timing requirements apply:

  • For an existing 401(k) plan to add a safe harbor matching provision, employees must be provided with a “safe harbor notice” describing the new safe harbor match no later than December 2nd of the prior year (i.e., at least 30 days prior to the beginning of the year in which the safe harbor matching provision will be effective).
  • If the safe harbor contribution provision is added to the plan before December 2nd of the year in which the safe harbor contribution will be effective:
    • The safe harbor contribution for the first year must be nonelective rather than match, and
    • The safe harbor nonelective contribution for the first year must be equal to at least 3% of eligible employees’ plan compensation for the plan year
  • If the safe harbor contribution provision is added to the plan on or after December 2nd of the year in which the safe harbor contribution will be effective:
    • The safe harbor contribution for the first year must be nonelective rather than match,
    • The safe harbor nonelective contribution for the first year must be equal to at least 4% of eligible employees’ plan compensation for the plan year, and
    • The plan amendment adding the safe harbor contribution provision doesn’t need to be adopted until the end of the following plan year.  This is significant because it will enable plan sponsors to wait and see whether the plan would otherwise pass the ADP test, and – if the plan fails the ADP test – the plan sponsor could elect to amend the plan retroactively to make the plan safe harbor for the year of the ADP testing failure so that corrective refunds to HCEs are not required (and the safe harbor 4% nonelective contribution would be allocated on eligible employees’ plan compensation for the plan year).

Summary

For a brand new 401(k) plan to include a safe harbor contribution provision in its initial year, employees must be able to make 401(k) salary deferral contributions for at least the final three months of the year (i.e., starting no later than the first payroll of October for a calendar year plan).  For both brand new and existing 401(k) plans, plan sponsors can wait until after they run their year-end ADP test to determine whether they pass, and – if they fail the ADP test – they have the option to amend the plan to be safe harbor retroactive to the beginning of the plan year of the ADP testing failure.  (With these retroactive amendments, a plan sponsor can only use safe harbor nonelective but can’t use safe harbor match, and the nonelective contribution percentage must be equal to 4% instead of 3%).

Because a brand new 401(k) plan must allow employees to make salary deferral contributions for at least three months in order to be safe harbor in its initial year – and because it typically takes at least six weeks to get a brand new 401(k) plan set up to start receiving contributions – it is recommended that the setup of a brand new safe harbor 401(k) plan begin no later than early August (and sooner if possible).

For more information please visit www.trpcweb.com or contact us.