The Differences Between Traditional 401(k) and Safe Harbor 401(k) Plans (2024)

By Allison Brecher, JD

Setting up a company-sponsored retirement plan offers some appealing tax benefits among other incentives. Both traditional 401(k) and safe harbor 401(k) plans help boost tax savings and retain employees, for instance, but safe harbor plans have a few unique differences. Because of pending 2021 deadlines, though, now is the time to explore the potential for safe harbor plans with your clients.

The first point to consider, then, is timing. Unlike traditional 401(k) plans, safe harbor plans are required to be in effect for at least three months of the calendar year to reap the tax benefits for that calendar year. As such, all plans are required to be set up by Oct. 1. However, because all new plans require employers to provide notice to employees within a “reasonable period” – typically 30 to 90 days before the beginning of each plan year – most safe harbor plans need to be set up by late summer.

Clients that already offer a retirement plan but may be interested in the benefits of a safe harbor plan may be able to amend the plan to become safe harbor, but there are deadlines for this too. Any switch to a safe harbor plan must happen no later than Nov. 30, 2021, to realize the benefits for the current calendar year.

A significant advantage of safe harbor plans over traditional 401(k)s is the elimination of nondiscrimination testing. Nondiscrimination tests confirm that an employer’s matching contributions do not discriminate against lower-paid employees, and these tests can be time consuming and/or result in the employer having to contribute additional funds to the plan. The lack of testing also streamlines administrative tasks, which may be appealing to small-business clients who lack dedicated administrative resources or have a considerable ratio of highly compensated employees versus non-highly compensated employees.

There is a difference in employee contributions, too. Safe harbor plans require employers to contribute to their employees’ accounts whereas a traditional 401(k) plan does not. They can do this in one of two ways: nonelective contributions or matching. Nonelective contributions require the employer to contribute a minimum of 3% of employees’ compensation, regardless of whether the employee contributes to the plan. Matching contributions, on the other hand, incentivize employees to contribute a percentage of their paycheck because that is the only way for them to receive a match. Companies may construct matching as either a basic match (100% on the first 3% of deferred compensation, plus a 50% match of the next 2% of their compensation) or an enhanced match (100% of employee contributions from a minimum of 4% compensation to a maximum of 6%).

Another difference comes with vesting schedules. While a traditional 401(k) plan can have a vesting schedule of up to a three-year cliff or six-year graded for employer contributions, those same contributions to a safe harbor plan are completely and immediately vested.

Regardless of the type of 401(k) plan a client sets up, there are impactful tax savings to be had. The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 created tax incentives that can significantly offset the cost of setting up a plan. Small businesses are eligible for a tax credit of $5,000 per year for three years when offering a retirement plan for the first time. Furthermore, adding automatic enrollment to any small plan brings an additional $500 credit for three years. Both credits may be used simultaneously, driving accessibility and incentivizing small businesses to get started.

There are many considerations when recommending a retirement plan – who to work with, what to offer, how to administer – but simply having a plan, of any type, can be a huge benefit to employers and employees. So, whether your clients are being proactive in their search for a retirement benefit plan or if you are the one to plant the seed, it’s important to be equipped to either offer guidance or know where to turn. Understanding the difference between standard and safe harbor 401(k) plans is a great place to start.

Allison Brecher, JD, is general counsel with Vestwell in the Greater New York City area. She has more than 15 years of legal and regulatory experience, handling employee benefits, ERISA, regulatory matters, data privacy, and electronic discovery, and can be reached at allison.brecher@vestwell.com.

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