The term ‘401(k)’ is often used by many as a singular umbrella term to refer to any and all retirement benefits offered to employees by an employer. However, there are a few different 401(k) arrangements that employers can offer, including the Safe Harbor 401(k).

Within the Safe Harbor, there are 2 different types of plans. They are the traditional Safe Harbor 401(k) and the Qualified Automatic Contribution Arrangement (QACA).

Safe Harbor provisions made their way onto the scene in 1996 as part of The Small Business Job Protection Act of 1996 (SBJPA). The provisions were meant to be a method through which small business owners could satisfy complicated nondiscrimination testing requirements while also offering savings benefits to both employers and employees.

Key Elements Of A Traditional Safe Harbor 401k

  • Employer contributions are immediately vested, this means if a participant terminates employment they keep the employer contributions into their 401(k) plan
  • Participation in Safe Harbor provisions allows the employer to be exempt from annual 401(k) compliance testing, as long as certain criteria are met; this allows highly compensated employees to contribute more into their 401(k) plan than they otherwise would be legally able to due to ADP/ACP testing limits
  • Allows business owners to make maximum 401(k) contributions to their own plan and receive contributions from their own business into their 401(k)
  • Allows for tax deductions for contributions made to employee plans
  • Can solve contribution restrictions for Highly Compensated Employees and owners resulting from low employee participation in the plan

You may wonder why a business would want to use a Safe Harbor 401(k). Essentially it is a trade-off: the government allows employers to offer the Safe Harbor in exchange for the exemption to certain compliance criteria that traditional 401(k)’s must adhere to yet can be overwhelming for some employers to meet.

In exchange for saving you (the business owner) the headache of compliance testing, the government wants to make sure that your employees receive benefits that will help them save for retirement.

401(k) Discrimination Testing

Traditional 401(k) plans must be evaluated yearly and pass nondiscrimination (Annual Deferral Percentage – ADP & Actual Contribution Percentage – ACP) and top-heavy tests in order to retain qualified status with the IRS. These tests ensure that Non Highly Compensated Employees and Highly Compensated Employees (which, in small businesses tend to be the owners and top employees) are both given a fair opportunity to save for retirement, among other things.

Small business owners are more prone to failing these tests since they tend to be the ones with higher ownership of assets. If these tests fail, business owners can find themselves in an expensive and stressful mess.

The costs for failing any of the tests can be even more expensive, in some cases, than paying automatically vested contributions to employees. Also, if a 401(k) plan fails nondiscrimination testing, Highly Compensated Employees (HCEs) can also be affected and receive refunds from the IRS of money that these employees had contributed to their 401(k).

When a Highly Compensate Employee is forced to receive a 401(k) plan refund, it can increase their taxable income and cause employees to lose faith and trust in their employers. With these issues in mind, it’s easy to see why a Safe Harbor 401(k) is so attractive.

Maximize Contributions With A Safe Harbor 401(k)

With a Safe Harbor 401(k) plan, you and your HCEs, if applicable, can make the maximum pre-tax contributions, which is $19,000 for 2019. ‘Catch-up’ contributions limits for older plan participants are also permitted.

These retirement plan contributions are tax deductible in most situations. Without a Safe Harbor plan, HCEs—which includes you the owner—may be unable to contribute the full allowable annual amount to the 401(k).

Why? Well, remember that a traditional 401(k) plan requires a business to pass nondiscrimination testing in order to maintain the plan. The very need to pass those tests, low HCE employee participation in the plan.

Depending on how the plan is set up and operated, restrictions may also be placed on HCEs in terms of contribution limits that would be below the annual maximums. Adopting a Safe Harbor 401(k) plan allows the business to automatically pass those compliance tests and allows for the maximum contributions to be made by all employees. Making full contributions to a 401(k) is essential for successful retirement planning.

Avoid IRS testing with Safe Harbor 401(k) plans

In order to avoid complicated and tedious IRS testing requirements, you will have to meet the minimum standard of Safe Harbor provisions. You can do this by fulfilling the appropriate matching requirements for participating 401(k) plan employees or by making the required contributions for employees who elect not to participate.

However, certain activities performed by an employer or plan participant may nullify exemption of plan testing, these include:

  • Employer made discretionary profit sharing contributions
  • Certain discretionary matches
  • Non-Roth after-tax contributions made by participating employees

An employer made, discretionary profit sharing contribution is when an employer makes an additional pre-tax contribution to an employee’s plan. As the name implies, this contribution is made, if at all, at the discretion of the employer.

A discretionary match is similar and occurs when employers use different formulas and rules, which the employer may change year-to-year, to determine matches for employee contributions. This does not satisfy Safe Harbor rules and depending on how this is done, you may have to pass an actual contribution percentage test.

Other than these exceptions, it is a fairly straight forward process in order to meet Safe Harbor requirements and avoid annual testing.

For business owners, avoiding some of these headaches would be great! But it is important to fully understand all of the rules and expenses that come along with a Safe Harbor 401(k) plan. Although it offers many advantages, it’s not a one-size-fits-all plan that benefits all businesses.

Things to consider about the Safe Harbor 401(k)

  • Contributions are immediately vested
  • Employer contribution requirements exist

Under a Safe Harbor, employer contributions are immediately vested. This means that the employee can take that vested money with them if they change employers.

Of course, the contributions that the employee makes to their 401(k) are always fully vested immediately upon making the contribution. Compare these automatic and immediately vested Safe Harbor contributions to a traditional 401(k) vesting schedule in which an employee earns full vested status after a period of time with the same employer.

Common Traditional 401(k) Vesting Schedules Used

United States law has established a minimum vesting standard as part of The Protection of Employee Benefits Program. There are 3 typical vesting schedules used by employers:

  • A Graded Schedule
  • A Cliff Schedule
  • Immediate Vesting (Applicable in Safe Harbor plans)

Graded schedule

Under a graded schedule, an employee becomes gradually vested. ERISA rules limit the time it takes to become 100% vested to no longer than 6 years. A gradual vested schedule may look like this:

Years of ServiceGraded % Vested

Cliff Schedule

The cliff vesting schedule is one in which an employee works for 1-3 years and yet has 0% of the employer contributions vested, but after completing the employer designated time limit, which under ERISA rules cannot exceed 3 years, the employee becomes 100% vested.

Years of ServiceCliff Vesting Schedule

If the 401(k) participating employee separates from employment prior to the completion of 3 years, according to this example, the employee has no right to keep the money that the employer contributed to the 401(k).

Immediate Vesting

As is required in a Safe Harbor 401(k) plan, employer contributions are immediately vested. Therefore, if you are considering using a Safe Harbor 401k, the vesting schedule is decided for you.

Employers may also decide to participate in an immediate vesting strategy even if they don’t offer a Safe Harbor 401(k) plan.

Regardless of the vesting schedule used, the IRS requires that all participating 401(k) employees be 100% vested by the time they reach normal retirement age or when the employer terminates the plan. Normal retirement age, under current US law, is:

  • The age specified under the terms of the retirement plan
  • The later occurrence of
    • The employee turning 65 years of age
    • Upon completing the 5th anniversary after the employee began participating in the retirement plan

Required Safe Harbor 401(k) Matching Rules

You must follow the safe harbor 401(k) matching rules to maintain your safe harbor status.
Follow the Safe Harbor 401(k) rules or risk disqualification.

There are 3 major matching structures under the Safe Harbor 401(k) that employers can use:

Non-elective Safe Harbor

In a non-elective safe harbor 401(k) plan, the employer contributes at least 3% of employee compensation to the employee’s 401(k) regardless of whether or not the employee makes contributions. The match is automatically vested and the employee can take that match money with them when they separate from the employer.

Basic Safe Harbor Match

In the basic match, the employee must make contributions to their 401(k) and the employer matches 100% of the first 3% deferred, and then 50% of the next 2% deferred.

Enhanced Match

Like the basic safe harbor match, the employee must contribute to their 401(k) plan in order to receive the enhanced match, which must also be larger than the basic match.

Generally, an enhanced match is an employer contribution of 100% of the first 4% of each deferral made by the employee.

  • The enhanced match percentage can’t increase as employee deferral percentage increases
  • Highly Compensated Employees can’t receive a higher rate of a match than what would be provided to a Non-Highly Compensated Employee for a given deferral rate.

What Is A QACA?

As I mentioned above, there are two types of Safe Harbor plans. Let’s look at the second type of plan, the Qualified Automatic Contribution Arrangement (QACA).

QACA was established in 2006 with the purpose of increasing employee contributions to retirement funds. Regardless of the exact type of 401(k), even those outside of the Safe Harbor plans, automatic enrollment features can increase employee participation and satisfaction.

Key elements of QACA

  • Includes Safe Harbor provisions
  • Excludes the plan from having to pass ADP and ACP nondiscrimination testing
  • Must establish a uniform minimum default percentage, starting at 3%
  • Graded uniform minimum default percentage with gradual increases
  • Not to be confused with other types of automatic enrollment, of which 3 types exist but QACA includes Safe Harbor provisions
  • Employees must be 100% vested within 2 years from the start of participation in QACA
  • The appropriate legal notice required

Under QACA, the IRS requires that the employer decides between the following two contribution schedules:

  1. A matching contribution:
    • Employee contribution of up to 1%: matched 100% by employer
    • Employee contribution of >1% up to 6%: matched at 50% by employer
  2. A nonelective contribution:
    • The employer will contribute 3% of compensation to all participants, even to employees who elect not to contribute any amount to the plan.

How Do The Gradual Increases To The Minimum Default Percentage Occur?

QACA rules mandate that employers set a minimum contribution requirement of 3% for employees enrolled in the plan. Remember that the purpose of QACA was to increase employee participation and boost retirement savings.

The government hoped that by gradually increasing the percentage of contributions made by employees, they would feel less pressure and at the same time increase savings.

Minimum contribution rates start at 3% and increase by 1% every year to a minimum of 6% and a maximum of 10%.

What Are The Advantages Of Choosing A QACA Over A Traditional Safe Harbor 401(k)?

For the employer, the main advantages of choosing QACA over a traditional Safe Harbor 401(k) are:

  1. QACA is less expensive than traditional Safe Harbor. Under the traditional plan, an employer would have a 4% maximum match whereas, under QACA, the maximum percentage is 3.5%
  2. Employer contributions or matches are subject to a cliff vesting schedule. Employers can decide to make employer contributions fully vested after 2 years of employee participation. If the employee leaves the job prior to the 2 years, he or she can’t take the employer contributions with them. This contrasts from the immediate vested contributions under a traditional Safe Harbor 401(k).

What Are Some Important Dates For Establishing A Safe Harbor Plan?

To set up a Safe Harbor plan for the current calendar year, the plan must be effective on or before October 1st in order to receive an exemption from 401(k) compliance testing.

If you want to set up a Safe Harbor plan for the following year (starting January 1st), including changing from a traditional 401(k) to a Safe Harbor, legal notices must be sent to employees by December 1st, which fulfills the 30 days of notice rule.

Can A Plan Be Changed From A Traditional Safe Harbor To A QACA Or Vice Versa?

Yes, you can elect to make this change but you are prohibited from making the change mid-year.

You are generally prohibited from making any mid-year change that would negatively affect participating employees, such as:

  • Increasing years of service required for full vesting
  • Narrowing or reducing the number of employees eligible to receive Safe Harbor benefits
  • Changing the formula used to determine matching contributions

What Are The Requirements For Employee Notification Of These Plans?

You must provide appropriate notice at the beginning of participation eligibility within the plan, annually, and if changes in the plan are to be made. Review the IRS links for required notice content for both the Safe Harbor 401k and QACA, however, a summary of the notice requirements are below.

For traditional Safe Harbor 401k plans:

  • The corresponding matching or nonelective contribution formula to be used in the plan
  • Any other contributions that could be made to another plan, including discretionary matching contributions, and the conditions in which they would be made
  • The type and amount of compensation that may be deferred,  how the employee can make, and the time periods for making such elections  
  • The withdrawal and vesting rules

For QACA plans:

  • The default percentage rate for automatic enrollment contributions
  • Amount and timing of any increases to automatic contributions
  • Type and amount of the employer contributions
  • The right to not participate and exactly how to elect to not participate
  • How to elect to contribute an amount different from the plan’s default percentage rate for automatic enrollment contributions
  • How to make an investment election, if allowed under the plan
  • How the automatic contributions will be invested in the case that the employee does not make an investment election if the QACA contains two or more investment options

What Are The Tax Benefits Of The Safe Harbor 401(k)?

  • You can make full contributions to your 401(k), even if employees decide not to
  • Those contributions are tax deductible, with some exceptions
  • Deduct the contributions made to employee plans up to 25% of total compensation payroll

Is A Safe Harbor 401(k) Or QACA Right For My Business?

Although these plans provide several benefits to both employers and employees, they may not be right for your business. Business owners have to look at all of the information and details while considering their particular business circumstances, tax benefits, and expenses.

Offering benefit packages that include retirement plans with different vesting schedules, contributions, or matches can boost recruiting and incentivize employees to stay with your company. The altruist in me also wants to remind you you’re actually helping your employees create both a memorable and purposeful retirement!

But like most important decisions, you shouldn’t make them alone. If you need help deciding on which 401(k) plan is best for your business, contact me now and I will be happy to help you make the best choice and answer your questions.


Small Business Jobs Protection Act

IRS Auto Enrollment

IRS Safe Harbor

IRS Employer Matching & Contributions Bulletin


Minimum Vesting Standards- Cornell Law