Traditional Vs. Safe Harbor 401(k) Plans, Which One is Right for You?

A question we hear frequently is, “What’s the best 401(k) design for my business?” As cringeworthy as this may sound, the correct answer is that it depends.

According to the National Compensation Survey, only 56% of companies in the United States offer a 401(k) plan. As astonishing as this statistic may seem, we’ve found that oftentimes business leaders already understand the importance of providing a 401(k) to their employees, but aren’t sure how to develop a plan that satisfies the priorities of their business, while providing a path to financial freedom for their employees at the same time. With all the options available in the marketplace, a 401(k)-design strategy that’s best for your business can be easily overlooked. Here we’ll provide a brief overview on two of the more popular plan designs that might be considered and highlight the differences to give guidance towards a plan that makes sense for your company and its people.

Safe Harbor Plan Design

Safe harbor 401(k)  plans are one of the most popular choices. A key factor to their popularity is that safe harbor plan design provides all eligible plan participants with an opportunity for an employer contribution. The safe harbor contributions can also be used to automatically satisfy many of the IRS’s annual compliance testing requirements. These annual compliance tests are referred to as the actual deferral percentage (ADP), actual contribution percentage (ACP) and top-heavy tests. Their purpose is to ensure the plan doesn’t overly skew benefits towards high earning employees and owners compared to the rest of the employee group. This unique ability of a safe harbor plan often can be worth the trade-off to business owners because they are typically the ones to bear the consequences of a failed test. Although there are big advantages, there are a few trade-offs to a safe harbor design. A plan sponsor interested in a safe harbor may consider the following design options: 3% Nonelective, Basic Match, Enhanced Match, or Qualified Automatic Contribution Arrangement (QACA).

A unique disadvantage to a safe harbor plan design is the vesting schedule. All safe harbor plans must immediately vest employer contributions for an employee unless they use the QACA contribution which allows for up to a 2-year vesting schedule.

Traditional 401(k) Plan Design

Another popular plan design option is the traditional 401(k). This employer sponsored retirement plan allows employees to defer compensation and employers to contribute to employee retirement accounts just like a safe harbor option. The key advantage of the traditional plan design is the flexibility it allows for plan sponsors when determining design characteristics such as vesting schedules, employee eligibility, and employer contributions. This flexibility allows employers to tailor a plan specific to their organizations needs and help combat issues that may be hindering their business such as employee turnover. For example, if a company is facing high employee turnover, a desirable plan design may entail a longer waiting period for eligibility for employer contributions (up to 2 years) or longer vesting schedules to encourage longer employment. If the employee participation in your company 401(k) plan is high, the traditional plan may be a good option to consider.

Plan Design Comparison

With the information we’ve covered, both plans can seem like a viable choice but what is the best for your business and its employees? The key areas that usually tip the scales one way or the other are compliance testing, employee participation, retention, and the amount you expect to contribute towards your employee retirement accounts. Below is a summarized chart of the pros and cons for each design option that a plan sponsor may think about:

Associated Bank’s Retirement Plan Consultants are always happy to assist you in further questions you might have about the retirement plan that is provided to your employees. If you’d like to discuss further, please call 414-347-2033 or email at Tyler.Slaght@associatedbank.com.