Safe Harbor Plans 






                                      The Safe Harbor Plan
                                The SMART 401(k)

Safe-harbor 401(k) plan design permits an employer to avoid discrimination testing of the rates of employee elective de­ferrals and/or employer matching contributions (ADP / ACP test­ing).

The benefit for avoiding testing is maximized contributions for the highly compensated. The safe harbor plan design waives the need for non discrimination testing and permits the company owners or those earning over $95,000 a year to contribute up to $20,000 to the plan on a tax deferred basis.

With the 401k SafeHarbor design, the employer matching contribution can be used to satisfy any top heavy requirements. (A plan is top heavy when more than 60 percent of the assets are held by the owners and key employees. A top heavy plan is required by the IRS to give all eligible plan participants an additional contribution equal to the lesser of one-third of the contribution received by the highest paid key employee or 3 percent of compensation). 

               Two Types of 401k Safe Harbor Designs.

One type is the safe-harbor non-elective design of 3% of compensation. Generally, a 3% contribution is provided to all employees eligible to make elective deferrals to the plan. The guaranteed contribution requires that a 3% employer contribution be made each plan year, unless the employer amends the plan and removes the provision before the start of the new plan year. The 3% is 100% employee vested.

The other type of safe-harbor design is a matching contribu­tion. There are two options from which to choose, the basic or the enhanced match. The basic safe-harbor matching contribution is defined as a 100% match on the first 3% deferred and a 50% match on deferrals be­tween 3% and 5%.
Alternatively, the employer may choose an enhanced match­ing formula equal to at least the amount of the basic match; for example, 100% of the first 4% deferred.

            Timing the 401k Safe Harbor Adoption

Safe-harbor 401(k) plan provisions may not be added to an exist­ing 401(k) plan in the middle of a plan year. Instead, the plan must be timely amended to add the safe-harbor 401(k) provi­sions for the next plan year. In an exception to the timing requirements for giving the safe ­harbor notice, a new 401(k) may adopt a safe-harbor design at the same time that the plan is established, assuming the notice is provided simultaneously. There must be at least 3 months remaining in the plan year to make elective deferrals for a plan to use this provision.
An existing profit-sharing plan that is amended to add a 401(k) feature is eligible to use this rule. Further, a totally new business entity establishing a new 401k plan may have as short as a one-month initial plan year (assuming that the initial year is then followed by the normal 12 month year). 

                        401k Safe Harbor Conditions

The sponsor of a 401k plan using a guaranteed 3% must make that contribution regardless of its subsequent financial condition during that plan year. However, an employer may stop mak­ing safe-harbor matching contributions by providing a notice to the employees. This notice must be given at least 30 days before the contributions are to be stopped. If an employer stops safe-harbor matching contributions before the plan year is completed, the ADP and ACP tests must be preformed for the entire plan year.

Investment representatives hooking the annual plan limits with a “SafeHarbor” plan design will end up providing their clients with three smart benefits
---Higher tax deferred contribution levels for the company owners and highly compensated
---Non discrimination testing issues are eliminated and any
---Top heavy issues are satisfied as well.


                                      That’s a retirement triple play.

Roth 401K




                        ROTH 401(k) Contributions

A 401(k) plan may now permit a participant to designate some or all of his contributions as after-tax Roth contributions ("Roth Designated Contributions").

Although Roth 401k Contributions are treated as regular 401(k) contributions for most purposes, they are currently includible in gross income. However, upon separation from service, a qualified distribution of Roth 401k Contributions (and earnings) is excludable from gross income for income tax purposes.

If a plan sponsor wishes to allow for Roth 401k Contributions, the plan must be amended by the last day of the first plan year in which the plan permits participants to make Roth 401k Contributions.

For example, if the Plan permits Roth 401k Contributions during January of 2006 and the plan has a December 31 year end, the plan would need to be amended by December 31, 2006.

                             Key Features of Roth 401k Contributions:

(1) The Roth 401k Contribution can only be establised in an 401(k) plan that also offers the opportunity to make pre-tax contibutions. The Roth contibution can not stand alone as a separate plan nor  can it be the sole contribution source.

(2) The Roth 401k Contributions must be designated irrevocably by the employee as a Roth Contribution. You can not change your mind and have the Roth 401k Contributions recharacterized as pre-tax 401k contributions.

(3) The Roth 401k Contributions are includible in the employee’s income (contributions are made on an after-tax basis).

(4) The Roth 401k Contributions must be accounted for separately from all other contribution sources.

(5) The sum of the Roth 401k Contributions and regular pre-tax 401(k) contributions may not exceed the annual limit on regular 401(k) contributions. ($15,000 in 2006 for a participant under age 50, $20,000 for a participant age 50 or over.)

(6) Roth 401k Contributions may be rolled over to a Roth 401k Contribution account in another 401(k) plan or Roth IRA but Roth 401k Contributions can not be rolled over to any other account

(7) A qualified distribution of Roth 401k Contributions (and earnings) is not taxable. 
               A qualified distribution: 
                           (a) must be made more than five years after the
                                   first Roth 401k Contribution is made, and 
                           (b) must be made: 
                                    (1) after the participant is age 59-1/2; 
                                    (2) to a beneficiary after the death 
                                            of the participant; or 
                                     (3) on account of disability.

(8) Roth 401k Contributions are subject to the qualified plan required minimum distribution rules. The required minimum distribution rules may be avoided by a rollover to a Roth IRA prior to attaining age 70-1/2.

(9) Roth 401k Contributions are subject to the same limitations on withdrawal as regular 401(k) contributions (age 59-1/2, hardship). 

                                      Roth 401k Distribution Example


      Dave Roberts is age 52 and has elected to contribute $3,000 a month as a regular 401(k) contribution to his employer's 401(k) plan beginning January 1, 2006. On April 30, 2006 after speaking with his investment advisor and making $12,000 in pre-tax contributions, Dave completes a new election form where he elects to contribute $1,000 per month as a Roth 401k Contribution. At the end of December, 2006 his contributions stop because he has reached the combined 401(k)/Roth limit of $20,000. (Mr. Jones was age 50 or over and his limit is $20,000 in 2006.)

      It’s now the end of 2007 and Dave Roberts has $40,000 in his Roth 401k Contribution account. In February 2008 Dave terminates from the company and receives a cash distribution of his entire Roth Contribution account. The Roth 401k Contributions made are tax free but income earned on the Roth 401k Contributions paid to him in 2008 will be taxable because the distribution was made less than five years after the first Roth 401k Contribution was contributed. Assuming no exception applies to the early distribution penalty, an added tax of 10% will be paid on the income distributed.

401k Case Studies

                                                     1. Quality Health HMO 401(k) Plan



                     CLIENT:   Quality Health HMO 401(k) Plan

     CHALLENGE:   Problem in recruiting new employees.
                             Company's 401(k) plan is a Safe Harbor
                             plan with a age 21 and a one year wait
                              to be eligible for the plan. Prospective 
                              employees complained about the wait
                              and want to defer immediately. The 
                              Company was concerned about the
                              additional cost of reducing the wait and
                              granting the Safe Harbor Match 
                              immediately.

       SOLUTION:    We amended the plan to allow for 
                              immediate entry for deferrals only. The
                              Safe Harbor Match eligibility would remain
                              at one year.
                              This solution requires the disaggregation
                              of the plan into two separate groups-
                              the safe harbor group and the excludable group
                              of those with less than one year of service. The
                              safe harbor goup gets a "pass" on testing and 
                              the excludable group needs to be tested.

         RESULT:       Offer acceptance of prospective employees
                              increased 14% with no additional Match cost
                              to the Employer.