When is a Safe Harbor Plan Not so Safe?

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.  A recent call with an advisor in Ohio is representative of a common inquiry involving a safe harbor 401(k) plan. The advisor asked: “Does my client have to be concerned with testing employee after-tax contributions in a safe harbor 401(k) plan?”

Highlights of Recommendations 

• Great question!  Some may find this surprising, but—yes—despite the safe harbor design, the after-tax contributions are still subject to the actual contribution percentage (ACP) test [Treas. Reg. 1.401(m)-3(j)(6)].  

• After-tax contributions are also considered in the annual additions limit under IRC. Sec. 415, which limits each participant’s plan contributions for the year to 100 percent of compensation up to $58,000 for 2021 ($64,500 for participants age 50 and over making catch-up contributions).    

• In a conventional (i.e., nonsafe harbor) 401(k) plan, the actual deferral percentage (ADP) test considers whether employee salary deferrals in a 401(k) plan are made on a nondiscriminatory basis, while the ACP test considers whether both employer matching and employee after-tax contributions are nondiscriminatory.  

• Following a safe harbor 401(k) plan design allows a plan sponsor to automatically satisfy the ADP test with respect to salary deferrals and the ACP test with respect to employer matching contributions. However, Treasury regulations explicitly state employee after-tax contributions must still undergo the ACP test despite a safe harbor design. 

Conclusion

It is true—a safe harbor 401(k) plan design can provide relief from ACP testing with respect to employer matching contributions, but not employee after-tax contributions. Employee after-tax contributions must still be tested to ensure they are nondiscriminatory.  Financial advisors who can demonstrate their knowledge of the intricacies of safe harbor plan designs are better positioned to support their 401(k) plan sponsor clients.