The Safe-Harbor Solution

by Stephen Kass on July 18, 2012

Effective as of 1999, the Small Business Job Protection Act of 1996 introduced
safe-harbor formulas for 401(k) plans that eliminate the need for companies to perform
annual nondiscrimination testing. These changes should allow small employers to
contribute higher amounts on behalf of highly compensated employees (HCEs).
Nondiscrimination tests effectively eliminate the ability of many small businesses
and professional firms to adopt 401(k) plans because non-HCEs often elect not to
participate. The result is that HCEs can defer little or no income under the plan.
The safe-harbor formulas provide a way for employers to avoid nondiscrimination
testing by adopting a plan with a relatively generous employer match – one that includes
a contribution of at least 4% of pay on behalf of all eligible employers (depending on
employee contributions).
Safe-harbor matching contributions must be100% vested at all times. Such
contributions generally may not be distributed to employees until the earlier of when they
terminated employment or reach age 59 ½.

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