It’s safe harbor season: Here’s what you (and your clients) should know
Now that tax season is behind you, you’re likely thinking of new ways to create efficiencies and minimize your clients’ tax burdens for next year.
One way to do this is by having them set up a company-sponsored retirement plan. While there are many plan types to consider, safe harbor plans offer some very specific benefits that can make them particularly appealing. As with traditional 401(k)s, safe harbor plans can help maximize tax savings and retain employees, but they are also a particularly popular plan design because they can significantly simplify responsibilities for the business owner.
While setting up a company-sponsored retirement plan is a good thing in any season, to realize tax benefits for 2021, summer is an ideal time to advise your clients on safe harbor plans. Here’s what they need to know.
Traditional 401(k)s require plan contributions to meet specific compliance testing requirements. The purpose of these tests is to verify that employer matching contributions do not discriminate against lower-paid employees. For example, a small business with fewer “rank-and-file” employees and more highly compensated employees may otherwise have difficulty passing compliance tests. These tests are complex and must be satisfied on an annual basis to take advantage of the tax benefits of having a plan. However, safe harbor plans are not subject to most of these annual nondiscrimination tests, which makes it much easier to keep the plan in compliance with regulatory requirements. It also means clients can avoid potential penalties and costs associated with testing, making them a great option for small businesses.
Safe harbor plans require employers to contribute to their employees’ accounts. Contributions can be limited to employees who make deferrals or offered to all eligible employees, but all contributions become fully vested when made. When it comes to contributions, your clients have the option to choose either a matching contribution or a nonelective contribution. If they elect a matching contribution, which rewards employees for saving for their retirement, they can choose from a basic (100% match on the first 3% of deferred compensation, plus a 50% match on deferrals between 3% and 5% of compensation) or an enhanced match (each tier must be as generous, if not more so, than the basic match). Nonelective contributions require the employer to contribute a minimum of 3% of compensation, regardless of if the employee contributes to the plan.
Safe harbor plans are not only a good option for employees, but also for business owners. Owners can contribute the maximum annual deferral amount to their own plan ($19,500 for 2021 plus any catchup contributions) as well as receive additional benefits from the company's matching contributions (after all, owners are "employees" too).
In order to set up a safe harbor plan, the government requires employers to provide notice about the plan and its features within a “reasonable period” prior to the start of the plan, usually at least 30–90 days before the beginning of each plan year. Safe harbor plans must be set up no later than Oct. 1, so that the plan is in effect for at least three months of the year, and employees must receive at least 30 days’ notice about the plan. For these reasons, the summer months (July and August) are the ideal time to help your clients understand their options and start the process. If your client has a different type of retirement offering but is interested in a safe harbor plan, they can always amend theirs, but keep in mind that they’ll need to do this no later than Nov. 30, 2021.
I’d be remiss not to mention the tax benefits of setting up a company-sponsored retirement plan. As with a traditional 401(k), safe harbor plans can help offset the business’ taxes by deducting applicable employee and employer matching contributions. And, of course, the more your clients contribute, the more they can save on taxes, too!
Just as important, tax incentives from the recently passed SECURE Act can significantly offset the cost of setting up a plan. Small businesses offering a retirement plan for the first time are eligible for a tax credit of up to $5,000 per year for three years. In addition, adding automatic enrollment to any small plan comes with an additional $500 credit for three years. The two credits can be used together, making plans more accessible to small businesses.
While safe harbor plans can sometimes be a more expensive option due to contribution mandates, the tax incentives and potential savings from automatically passing discrimination testing can more than make up for it. As such, they prove to be a great choice for small businesses looking for a simple option that simultaneously helps to prepare their employees for retirement while offsetting their own tax burdens.
Getting started is easy. Whether you already have your own offering, a preferred retirement plan advisor relationship or a favorite recordkeeper, everyone has the same goal of making the process simple for your clients. Keep in mind that some recordkeepers offer free consultations to business owners, while others charge for the service.
Regardless, Tax Day will be here before we know it. So, if you think a safe harbor plan might be right for any of your clients, the time to start preparing is now.
Allison Brecher, general counsel with Vestwell, has more than 15 years of legal and regulatory experience, handling high profile and complex litigation involving employee benefits, ERISA, regulatory matters, data privacy and electronic discovery. You may reach her at firstname.lastname@example.org.