To Safe Harbor or not Safe Harbor, that is the question

December 1 is pretty quickly going to be upon us, which reminds me that I have some notices to send out shortly. For those in the retirement plan business, we know December 1 marks the date that safe harbor notices have to be distributed to participants for a plan to be eligible as a safe harbor 401(k) plan for the 2012 calendar plan year. Since December 1 is before December 31, 2012, plan sponsors have to have a premonition that they might fail their 2012 discrimination tests in order to be a safe harbor plan.

Safe harbor plan design is one of the best developments in qualified plans in the last 15 years. It’s win win because the 100% vested contributions to plan participants allows the plan to get a free pass on ADP (deferral discrimination tests), ACP (matching contribution tests, if contribution made), and the Top Heavy test (making sure plan doesn’t substantially benefit Key Employees). In addition, if the plan sponsor elects the 3% non-elective safe harbor (3% of compensation contribution to participants, regardless of whether they defer or not), that 3% can also be used to satisfy the minimum gateway contribution to non-highly compensated employees in a cross-tested allocation  (which means that highly compensated employees can get up to 9% of compensation in this type of profit sharing contribution).

That being said, a plan sponsor has to be advised by their third party administration firm (TPA) and/or ERISA attorney why a safe harbor plan design might be a good idea. Here are some clues as to when plans need to go this route:

1. Plan has failed the ADP, or ACP, or Top Heavy Test (or all of them) in the past 1-2 years.
2. Plan has come close to failing the above tests in the plan year.
3. Demographically, plan has non-highly compensated employees that defer at a very low percentage.
4. Demographically, plan has a large group of highly compensated employees such as a professional practice (law firm, accounting, and medical practice).
5. Plan already uses a cross-tested, new comparability allocation for their profit sharing contribution.

If you are an advisor on a plan or a plan sponsor and you need to know whether a safe harbor design is a good idea for a specific plan, contact your TPA or yours truly.