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Dare to compare: Exploring Safe Harbor 401(k) plans


When the features of the SIMPLE IRA plan and the traditional 401(k) plan are combined into one plan, there are considerable advantages for both employees and business owners.

Key Points

Q. What are my options regarding Safe Harbor 401(k) plans when compared to other available qualified plans? I currently have a SIMPLE IRA.

A. Over the last few years, many small business owners have implemented SIMPLE IRA plans, because they didn't want to pay the various expenses associated with traditional 401(k) plans' reporting and nondiscrimination test requirements.

But, there is another alternative that allows for greater tax-deferred savings than the SIMPLE IRA, and still avoids the bulk of the administrative expenses of the traditional 401(k).

This article explores some of the details of the SH plan, along with some attractive planning strategies.

Advantages of SH401(k) plans

The primary reason any small business considers the SH plan is a desire to avoid the expensive nondiscrimination tests and IRS filing requirements associated with the traditional 401(k) plan.

Although the SIMPLE IRA plan eliminates these expenses, there is a trade-off.

Participants in a SIMPLE IRA plan are only permitted to defer salary up to $10,500 for 2007, with an additional $2,500 catch-up available to participants age 50 and over.

Traditional 401(k) participants, on the other hand, are permitted to defer up to $15,500 for 2007, with an additional $5,000 catch-up available to participants age 50 and over.

Additionally, a SIMPLE IRA plan does not permit the small business to make a discretionary profit-sharing contribution.

Safe Harbor options

Small businesses establishing the SH plan have two options for making contributions to employee accounts. Both of these options require the contributions to be fully vested.

Matching contribution: The employer matches 100 percent of non-highly compensated employees'(NHCE) salary deferral up to 3 percent of the employee's compensation, plus 50 percent of the NHCE's deferral between 3 percent to 5 percent of compensation.

This translates into a 4 percent matching contribution for employees deferring 5 percent of compensation or more. Employees making no deferral would receive no match.

Nonelective contribution: The business contributes 3 percent of pay to all eligible NHCEs , whether or not they elect to make a salary deferral contribution.

The matching contribution option

Most small business owners who make the decision to implement an SH plan are likely to choose the matching option.

It is very likely that the SIMPLE IRA plan will also have been considered, and the value of the higher deferral limit ($15,500 for 2007), plus the future tax-deferred growth on the additional contribution, outweighed any additional administrative expense.

The SH plan is usually a good fit where a low participation, or salary deferral rate, by the NHCEs causes the traditional 401(k) plan's ADP test to severely limit salary deferral contributions by the business owners and other highly compensated employees.

The SH match does not cost the employer much, because only those who make salary deferrals will receive any of the company match.

In other words, employees must "pay to play."

Additionally, the SH plan's match satisfies the 401(k) "top-heavy" minimum requirement.

All 401(k) plans are considered top-heavy when more than 60 percent of the plan assets are in the accounts of the key employees.

The majority of small business 401(k) plans are top-heavy by the end of the first plan year, especially when a high percentage of employees are family members or key employees.

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