Avoiding Safe Harbor 401(k) Plan Compliance Traps: Effective Administration, Contribution and Vesting Requirements

Description

The IRS nondiscrimination rules require a series of annual tests designed to measure whether a 401(k) plan disproportionately favors highly compensated employees. A properly structured safe harbor 401(k) plan is exempt from the IRS annual nondiscrimination testing requirements. This structure allows employers to avoid expensive corrections or refunding of 401(k) contributions.

A traditional 401(k) plan provides employers with significant flexibility in determining the amount of contributions (if any) to be made on behalf of all participants. That flexibility is limited by IRS rules requiring that traditional 401(k) plans meet specific nondiscrimination requirements, including the requirement to perform the actual deferral percentage (ADP) and actual contribution percentage (ACP) tests annually. Failing either of these tests can result in costly corrective measures, including taxable refunds to HCEs or additional contributions to ensure that the plan does not discriminate in favor of highly compensated employees.

Safe harbor 401(k) plans are exempt from the ADP and ACP testing requirements. Among other rules, the safe harbor 401(k) plan rules generally require employer contributions to be 100% vested. Also, under certain conditions, safe harbor 401(k) plans can also avoid being subject to the top-heavy rules of Internal Revenue Code Section 416. ERISA counsel and advisers must have in-depth knowledge of complicated IRS rules, employee notice requirements, key safe harbor provisions, and other items that are essential to being exempt from IRS annual testing requirements.

Listen as our panel discusses the IRS annual testing requirements for 401(k) plans, safe harbor 401(k) design options, including contribution and vesting rules, and methods to avoid compliance traps for plan sponsors.