If you run your own small business, you may well be in need of a good retirement plan. At one time, you might have considered a 401(k), only to discard the idea when you realized that some of the costs and burdens—such as testing requirements to ensure fair contributions to all employees—might prevent you and your key employees from fully benefiting from the plan. But now, you’ve got a “safe harbor” in which to place your 401(k), away from the uncertainties of whether you will benefit.
The Safe Harbor 401(k), created by the Small Business Job Protection Act of 1996, could help you build resources for your own retirement—and attract and retain employees. Like all 401(k) plans, the Safe Harbor 401(k) offers tax-deferred growth of earnings, the ability to make pre-tax contributions (which can lower a plan participant’s adjusted gross income), the opportunity for employer matching contributions and a variety of investment choices.
Furthermore, a Safe Harbor 401(k) permits discretionary profit-sharing contributions. And your contributions are considered business expenses, so they are tax-deductible. Plus, if your business had no plan, you may qualify for a tax credit to offset administration fees for the plan’s first three years.
Clearly, all these features are good for you and whatever employees you might have. But what really makes the Safe Harbor 401(k) a benefit to small businesses is less “testing.” You don’t have to deal with any non-discrimination testing to identify whether “highly compensated employees” (generally, business owners and management employees) contributed too much, as long as you adhere to the following contribution and matching guidelines:
You must contribute at least 3 percent of compensation to all “non-highly compensated employees.” All non-highly compensated employees are entitled to this money, even if they don’t elect to contribute to the plan. You can choose whether or not to provide this contribution to highly compensated employees, so you, as the business owner, can receive this contribution.
You must provide each non-highly compensated employee who participates in the Safe Harbor 401(k) with a dollar-for-dollar match on salary deferrals up to 3 percent of compensation, and a 50-cents-on-the-dollar match on deferrals between 3 and 5 percent of compensation. Alternatively, you can simply choose to make a dollar-for-dollar match on the first 4 percent of compensation. Keep in mind that this match is up to 4 percent of compensation—so if you have employees who contribute less than 4 percent of their compensation, you only have to match the amount contributed. Again, as the business owner, you also can receive this contribution.
The percentage of matching contributions for any highly compensated employee—including yourself, as the business owner—cannot be higher than the percentage provided to non-highly compensated employees.
However, a Safe Harbor 401(k) does offer a distinct advantage to highly compensated employees, because they are guaranteed the ability to defer from their pay the maximum amount ($13,000 in 2004, or $16,000 if they’re over 50) regardless of how much the non-highly compensated employees contribute. In a “regular” 401(k), this figure might have been reduced by the amounts the non-highly compensated employees chose to defer.
A Safe Harbor 401(k) is typically inexpensive to set up and maintain—and, with the absence of testing requirements, the benefits you can receive from the plan can be maximized and are predictable. To determine if this retirement plan is appropriate for your needs, contact your investment representative, who can work with your tax or business adviser. But don’t wait too long—the quicker you get your retirement money into a “safe harbor,” the less time it can take for your ship to come in.