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.
From just $107.88 $24.99 for Kiplinger Personal Finance
Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues
Sign up for Kiplinger’s Free 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.
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.
-
Crypto Trends to Watch in 2026Cryptocurrency is still less than 20 years old, but it remains a fast-moving (and also maturing) market. Here are the crypto trends to watch for in 2026.
-
Original Medicare vs Medicare Advantage Quiz: Which is Right for You?Quiz Take this quick quiz to discover your "Medicare Personality Type" and learn whether you are a Traditionalist, or a Bundler.
-
Ask the Editor: Capital Gains and Tax PlanningAsk the Editor In this week's Ask the Editor Q&A, Joy Taylor answers questions on capital gains tax rates and end-of-year tax planning
-
Time Is Running Out to Make the Best Moves to Save on Your 2025 TaxesDon't wait until January — investors, including those with a high net worth, can snag big tax savings for 2025 (and 2026) with these strategies.
-
4 Smart Ways Retirees Can Give More to Charity, From a Financial AdviserFor retirees, tax efficiency and charitable giving should go hand in hand. After all, why not maximize your gifts and minimize the amount that goes to the IRS?
-
I'm an Insurance Pro: If You Do One Boring Task Before the End of the Year, Make It This One (It Could Save You Thousands)Who wants to check insurance policies when there's fun to be had? Still, making sure everything is up to date (coverage and deductibles) can save you a ton.
-
3 Year-End Tax Strategies for Retirees With $2 Million to $10 MillionTo avoid the OBBB messing up your whole tax strategy, get your Roth conversions and charitable bunching done by year's end.
-
'Politics' Is a Dirty Word for Some Financial Advisers: 3 Reasons This Financial Planner Vehemently DisagreesYour financial plan should be aligned with your values and your politics. If your adviser refuses to talk about them, it's time to go elsewhere.
-
For a Move Abroad, Choosing a Fiduciary Financial Planner Who Sees Both Sides of the Border Is CriticalWorking with a cross-border financial planner is essential to integrate tax, estate and visa considerations and avoid costly, unexpected liabilities.
-
I'm a Financial Adviser: This Tax Trap Costs High Earners Thousands Each YearMutual funds in taxable accounts can quietly erode your returns. More efficient tools, such as ETFs and direct indexing, can help improve after-tax returns.
-
A Financial Adviser's Guide to Divorce Finalization: Tying Up the Loose EndsAfter signing the divorce agreement, you'll need to tackle the administrative work that will allow you to start over.
