Safe Harbor 401(k)s Can Help Small-Business Owners Keep Happy Employees

Immediate vesting and contributions by the employer regardless of the employee’s participation pump up workers. Employers get lower costs and tax benefits.

A lighthouse signals a safe harbor for passing ships.
(Image credit: Getty Images)

A safe harbor 401(k) is a great way for small-business owners to reward employees and keep them happy by making generous retirement contributions on their behalf that are immediately vested. And business owners know that finding and keeping good employees is one of the keys to increasing profits.

Immediate vesting means an employee doesn’t have to wait a few years in order to receive 100% of the employer contributions, so they can leave the company anytime if they want.

It also means that the employer avoids costly plan testing and may allow for much higher contributions for both the owner and highly compensated employees.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Nondiscrimination testing is one of the largest disadvantages for company owners running a traditional 401(k) plan. It makes the plan more expensive to operate and may reduce the allowable contributions that can be made by the owner and highly compensated employees.

This required testing is meant to ensure that all employees, regardless of salary or level of income, are treated equally by the plan.

Under testing rules, if non-highly compensated employees aren’t putting enough into the plan, then the amount owners and higher-paid employees can contribute will be limited.

A safe harbor 401(k) allows employers to avoid the nondiscrimination testing as long as they make a contribution on behalf of their employees.

A Safe Harbor 401(k) Requires Employer Contributions

In order to be considered a safe harbor 401(k), the employer must make at least one of two types of contributions on behalf of employees:

  • Contribute 3% of every employee’s salary regardless of whether they also contribute. 
  • Provide a 100% match of the first 3% of employees’ contributions and 50% of the next 2% of their contributions.

As long as this safe harbor minimum contribution is satisfied, the employer can then defer the maximum $20,500, or $27,000 for those age 50 or older, into their own 401(k).

Newly established safe harbor 401(k)s can also take advantage of a tax credit created by the SECURE Act of 2019 that can be as high as $16,500 for starting a new qualified company plan.

The tax credit is equal to $250 for each non-highly compensated employee who is eligible to participate in the plan with a minimum credit of $500 and a maximum credit of $5,000 for three years.

Also, if a business adds an auto-enrollment feature to its plan, it can claim a tax credit of $500 per year for three years.

Safe Harbor 401(k) Could Be More Cost-Effective for a Small Business

While mandatory contributions to employee 401(k) accounts can be an expensive proposition for a large company, for a small business it may be more cost-effective to make retirement contributions on behalf of employees rather than deal with the more expensive and burdensome nondiscrimination testing.

Remember the most important thing the employer may get out of making these employee contributions is keeping good employees happy.

And happy employees tend to stay. 


This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Mike Piershale, ChFC
President, Piershale Financial Group
Mike Piershale, ChFC, is president of Piershale Financial Group in Barrington, Illinois. He works directly with clients on retirement and estate planning, portfolio management and insurance needs.