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 and highly compensated employees (collectively referred to as “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”.

* In 2020 the salary deferral contribution limit is $19,500 for those under age 50 and is $26,000 for those age 50 or older

Prior to the SECURE Act – which was signed into law on December 20, 2019 – the timing requirements to include a safe harbor contribution provision in a 401(k) plan were much more restrictive than they are under the SECURE Act:

  • A safe harbor contribution provision could only be included in a brand new 401(k) plan if the plan were adopted by October 1st (assuming a calendar plan year), and
  • A safe harbor contribution provision could only be added to an existing 401(k) plan as of the first day of the next plan year

Timing Requirements under the SECURE Act

Under the SECURE Act, the timing requirements for including a safe harbor contribution provision in a brand new plan – or adding a safe harbor contribution provision to an existing plan – have been relaxed significantly.

For a Brand New 401(k) Plan

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

  • If the plan 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 plan is adopted after October 1st but before December 2nd:
    • 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 plan compensation for the initial plan year
  • If the plan is adopted between December 2nd and December 31st:
    • 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 plan compensation for 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 plan compensation for the initial year).

For an Existing 401(k) Plan

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

  • If the safe harbor contribution provision is added to the plan before December 2nd:
    • 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 plan compensation for the year
  • If the safe harbor contribution provision is added to the plan after December 2nd:
    • 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 plan compensation for the 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 plan compensation for the year).

Changes to Safe Harbor Notice Requirements under the SECURE Act

Another significant change under the SECURE Act is that a safe harbor notice is no longer required for 401(k) plans that make a safe harbor nonelective contribution.  For a plan that makes a safe harbor matching contribution, the notification rules are unchanged and a safe harbor notice must still be distributed to eligible plan participants between 30-90 days before the first day of the plan year.  Safe harbor plans with an automatic enrollment provision must still provide a notice between 30-90 days before the first day of the plan year whether the safe harbor contribution method is nonelective or matching.

Summary

Prior to the SECURE Act a brand new 401(k) plan needed to be adopted no later than October 1st to include a safe harbor contribution provision for its initial year, and an existing 401(k) plan could only add a safe harbor contribution provision as of the first day of the next plan year.  While it’s still more favorable for plan sponsors to include a safe harbor contribution provision by the deadlines that applied previously, plan sponsors now have much more flexibility with regard to the timing of adding a safe harbor contribution provision (including the ability to wait until after the ADP test results are known to amend the plan to include a safe harbor contribution provision for the year).

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