Safe harbor retirement plan considerations
Do you have a traditional 401(k) or 403(b) plan? If you participate in a traditional plan, it might be beneficial to consider adding or amending to a safe harbor plan.
In the recent 2019 Setting Every Community Up for Retirement Enhancement (SECURE) Act with further guidance provided by the Internal Revenue Service (IRS), there is now added flexibility to add or amend to a safe harbor 401(k) or 403(b) plan. Not only is there added flexibility to amend, but you can also avoid performing certain nondiscrimination tests that are required to be completed with traditional plans. You will also find that switching to a safe harbor plan boosts employee’s retirement plans with minimum employer contributions. We will walk through the SECURE Act changes in more detail to outline why to consider this switch and next steps.
Mid-year and Retroactive Adoption
Want to switch mid-year? You’re in luck. Prior to the SECURE Act, adoption of a safe harbor plan had to take place before the first day of the Plan. Thanks to the new law, you can retroactively convert a traditional 401(k) plan to a safe harbor plan with employer nonelective contributions. The safe harbor for employer nonelective contributions is implemented at a 3% minimum to all eligible employees.
Although the SECURE Act requires that you implement the plan 31 days prior to the plan’s current year end, there is small exception that allows you to adopt before the last day of the current plan’s year end. The plan sponsor is still allowed to retroactively implement, but the minimum jumps up from 3% to 4%. We advise plan sponsors to make your elections early to avoid the jump in the minimum nonelective contribution.
With this in mind, if you are concerned that your traditional plan may not pass nondiscrimination testing for contributions on behalf of highly and non-highly compensated employees, this concern can be mitigated by electing the retroactive adoption. If you choose to keep the traditional plan in place and fail the nondiscrimination test, a portion of the highly compensated employees’ contributions are returned to the employee. This amount is then subject to income tax which results in an unfavorable outcome for the employee. Or the plan sponsor may need to make qualified non-elective contributions to the non-highly compensated employees.
Elimination of Annual Notice Requirements
To help reduce administrative work for plan sponsors, there is no longer a requirement to send annual notices. It’s important to note that this change, permitted through the SECURE Act, is only for nonelective contribution safe harbor matching, NOT for safe harbor plans that use matching contributions.
Increased Auto-escalation Contribution Cap
The last notable change impacting safe harbor plans is the increase in auto-escalation to the contribution cap. Plan sponsors that elect to use a qualified automatic contribution arrangement (QACA) must default the employee’s contribution to at least 3% of the employee’s pay with an annual increase of 1% to at least 6%. There was originally a cap of 10% to the employee’s contribution, but this has now been increased to 15% which enhances the benefit for an employee’s retirement plan with the ability to contribute more if the plan sponsor chooses to elect a higher maximum. This change is not required, but worth noting for the value it can add for your employees.
Now is the time to start the conversation with your third-party administrators and other relevant service providers to outline the required amendments needed to implement a safe harbor plan. Whether it be at the beginning of the plan year or retroactively, these amendments should be submitted by the end of the first plan year starting in 2022. Most importantly, if you implement a safe harbor plan prior to 31 days before the end of the current plan year, you will save one percentage point per employee with the 3% minimum, rather than 4%.
For additional information, please contact your trusted advisor at HHM, today.