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Money Cents

Safe Harbor 401(k)s May Be A Retirement Plan Alternative For Small Businesses
By Shelley Phillips-Mills
Aug 1, 2005 - 1:48:00 PM

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As a small business owner, you know there are several retirement plan options available. And, as the number of small businesses continues to grow, it is important to provide your employees with the best options possible in order to retain them.

Selecting the best retirement plan that meets your needs and those of your employees can sometimes be difficult. It is important to look at the details of the plans to ensure that the plan you select is the most appropriate plan.

For example, many employers who currently maintain 401(k) plans are disappointed when they realize that, at the end of the year, they must refund contributions to highly compensated employees because of low or reduced participation levels from the rank-and-file employees.

To help business owners avoid this situation, a safe harbor 401(k) may serve as a better alternative to help enhance contributions for the highly compensated employees, while keeping overall administration costs in check.

A safe harbor 401(k) is a retirement plan that allows highly compensated employees to make salary deferral contributions up to the designated limit for a given year ($13,000 for 2004), regardless of the participation level of regular employees and as long as the employer commits to a certain level of contributions.

To understand the benefits of the safe harbor 401(k), you must first understand annual discrimination testing applicable in traditional 401(k) plans.  You may be asking – what is discrimination testing? The employer must perform two tests to ensure that the amounts deferred by employees and the employer’s matching contributions do not discriminate in favor of the business owners and other highly compensated employees.

The Actual Deferral Percentage test ensures that the rate of deferrals for highly compensated employees is not excessive compared with that of non-highly compensated employees. If a retirement plan fails this test, the employer must refund contributions to highly compensated employees (which are taxable to the employee) or make additional contributions on behalf of non-highly paid employees.

The Actual Contribution Percentage test applies to the rate of matching contributions on behalf of highly compensated employees versus the average employee in much the same way as the Actual Deferral Percentage test.

The advantage of a safe harbor 401(k) is that it does not require the complicated discrimination testing. Instead, the plan must meet both contribution and notification requirements and the employer must make a minimum fully vested contribution to the plan using one of the following methods:

Matching contributions for each eligible participating employee. Under the match formula, the employer will provide the safe harbor contribution to any employee that elects to defer, through salary deferrals, into the plan. This method has basic and enhanced match formulas.

The basic match formula is defined as a 100 percent match on the first three percent deferred and a 50 percent match on deferrals between three and five percent of salary. The enhanced match formula allows the plan sponsor to tailor the formula used to match. Nonetheless, it must be equal to at least the amount a participant would receive under the basic match.

Non-elective contributions of three percent of pay for all eligible employees. Under the non-elective formula, the employer will provide a minimum of three percent safe harbor contributions to all eligible employees, regardless of their participation in the plan.

All eligible employees must receive a written notice describing the applicable safe harbor provision between 30 and 90 days before the beginning of the plan year. This notice must be provided for each year the plan will be a safe harbor plan.

As you can see, a safe harbor 401(k) may be an attractive option for your small business and employees. Your financial consultant can help you sort through the options and find the most appropriate plan for your business. If you would like to receive the A.G. Edwards’ publication, “2005 Retirement Plans Overview for Professionals: A Summary of Common Business Retirement Plans,” please contact financial consultant, Shelley Phillips-Mills in Bangor at 1-800-947-5456.

This article was provided by A.G. Edwards & Sons, Inc., Member SIPC.

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