While a standard 401(k) plan is rather simple to set up for employees, it could be a pain for employers since it is their responsibility to guarantee that they’ve kept all the applicable complex government rules.
Hassle of standard 401(k) government tests
An essential requirement for most 401(k)-s is passing nondiscrimination tests every year to ensure that some categories of employees aren’t being favored unfairly at the expense of others, notes Steven Azoury, who owns Azoury Financial, a firm based in Troy, Michigan, as cited by US News and World Report.
Dan Beck, who is the CEO of “401GO”, a platform assisting small businesses to set up retirement plans, points out that the government’s nondiscrimination tests are designed to guarantee that 401(k) benefits fairly all people in a certain company.
What the tests do is inspect the savings rates of both highly paid and less highly paid employees, and seek out any excessive discrepancies between these two groups of workers as far as their 401(k) account deposits are concerned.
They also evaluate whether an owner or a manager of a business, i.e. a key employee, might own over 60% of all assets in a plan.
If that is found to be the case, it would necessitate corrective action.
Punitive measures for non-compliance with the government’s annual testing requirements could be really costly for an employer, which is why, especially in the case of small-business owners, it is worth considering opting for a safe harbor 401(k), instead of a standard one.
Highly beneficial to small-business employers
That is the case because the former provides a way of avoiding the annual nondiscrimination tests while still offering the same tax benefits to employees.
Simply because safe harbor 401(k) plans are guaranteed to meet government requirements without having to undergo annual checks.
Under those plans, in 2021, anybody may contribute up to a maximum of $19,500 (which will be $20,500 next year), while those aged at least 50 may include additional catch-up contributions of $6,500.
The catch for the employer is that it is supposed to be making obligatory contributions to the safe harbor 401(k) accounts of its employees, with the money being immediately vested.
The arrangement in question could be very costly for a big business but more cost-efficient for a small-business since safe harbor 401(k) plans tend to be cheaper to establish than traditional plans and avoid the burden of the annual nondiscrimination testing.
In short, while using the safe harbor framework for 401(k) might increase payroll costs, it may reduce administrative costs more substantially, and just be straight out more convenient by eliminating a giant bureaucracy hassle.
There are four types of 401(k) plans under the safe harbor framework that employers can choose from depending on the different match and contribution options.
Highly beneficial to employees as well
Apart from the advantages that safe harbor 401(k) offers to some employers, it also carries the potential to be highly beneficial to their employees.
That is in part due to the automatic employer contributions to the employee’s retirement fund, as well as the immediate vesting and the potential tax deductions.
As safe harbor 401(k) plans don’t require a minimum number of years served for an employee to have access to the month, they mean that funds deposited in such an account are for the worker to keep under any circumstances.
The fact that safe harbor 401(k)-s guarantee that employees do receive minimum contributions to their retirement makes the framework a win-win for them and their employers.
The number one recommendation for employers who have decided to use the 401(k) safe harbor framework, or would even just like to consider it, is to seek specialized professional guidance.