Docking Into 401(k) 'Safe Harbor'

By Jerry Kalish

It's that time of the year again: the 401(k) safe harbor notice requirement of December 1 is fast approaching.

If you’re not aware of the 401(k) safe harbor, it’s a provision in the retirement plan law that allows you as an owner to automatically meet the 401(k) discrimination test--and thus, avoid returning any 401(k) contribution. The dollars can be significant: 401(k) limits for 2010 will be $16,5000 plus $5,500 catch-up if you are age 50 or older. So what's December 1? It is the deadline for you to provide the required safe harbor notice to your employees for 2010.

You yourself can satisfy the safe harbor requirements for next year (after giving timely notice to your employees) by making one of two types of contributions:

* At least 3% or more of compensation to all eligible employees. Generally, the 3% contribution must be provided to all employees eligible to make elective deferrals to the plan even if they choose to make no contributions themselves.

* A matching contribution equal to 100% of the first 3% of employee contributions 50% of the next 2%. That is, if every employee contributes at least 5% of their compensation, the maximum employer match is 4% of total compensation.

But if economic uncertainties leave you undecided about whether you want to have a safe harbor 401(k) plan for 2010, then you can take advantage of certain safety valves that IRS regulations have made available.

On May 18, 2009, at the height of the economic meltdown, the IRS issued proposed regulations that allow distressed employers (those who have incurred a “substantial business hardship”) to reduce or suspend their safe harbor contributions to their 401(k) retirement plans mid-year. Although only proposed, the new rules can be relied upon immediately for plan amendments adopted after May 18, 2009.

But here’s another safety valve that may provide you even more flexibility, even if you haven’t sustained “substantial business hardship”: instead of distributing a safe harbor notice that guarantees the 3% contribution regardless of its subsequent financial condition, an employer can provide a “conditional notice” at least 30 days before the start of the plan year.

The notice would state that the employer may give a safe harbor contribution for the following year. And then, no later than 11 months later, the employer must provide another notice indicating that the safe harbor has been elected and the 3% contribution will be made for that year.

The above applies to the 3% safe harbor contribution across the board. But what about the safe harbor match: can it be stopped during the plan year? The answer is yes, by providing a notice to employees at least 30 days before the contributions are to be stopped.

1. There must be the proper plan documentation.

2. The 401(k) discrimination tests must be provided for the entire plan year.

Actually, there’s one more important consideration: your employee's expectations. You should try to go beyond the formal notice requirements when communicating with your employees.

There’s some fine print to consider, of course, and safe harbor plans are not for every business owner. The decision to use the safe harbor method to maximize your 401(k) contributions should be based on your objectives and your plan’s demographics. And that allows me to segue into my usual caveat: this column is for informational purposes only, and should not be considered tax or legal advice. You should discuss this matter with your own tax advisor.

Jerry Kalish is founder and President of National Benefit Services, Inc., a Chicago-based employee benefit consulting and administrative firm that serves private-held companies, publicly traded companies, and public sector employers. He blogs at The Retirement Plan Blog and can be reached at jerry@nationalbenefit.com.

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November 16, 2009 9:35 AM