• Shannon

A Safe Harbor Plan Makes “Cents”

401(k) plans require annual testing known as ADP and ACP. These tests are performed to determine if highly compensated employees and owners are contributing too much in comparison to other employees. This testing can put a cap on deferral amounts for the highly compensated employees. 401(k) Safe Harbor Plans give the highly compensated employees and owners the opportunity to contribute the maximum salary deferral limit, despite what the other employees contribute.


Dr. Smith is the Plan Sponsor of the ABC plan. He earns $200,000 per year and contributes $18,000 to his traditional 401(k) account. Dr. Smith’s only employee and office assistance, Ella, makes $30,000 per year and she contributes $1,200 per year to the traditional 401(k) account. Dr. Smith does not make a matching contribution to the plan.

The ABC plan is Top Heavy because Dr. Smith is a key employee and his account balance is >60% of the total plan assets. Because the plan is Top Heavy, ABC has to contribute $900 for Ella in order to maintain the qualified status of the plan. This is referred to as a Top Heavy minimum contribution.

The ABC plan also fails ADP/ACP testing because Ella is only deferring 4% of her compensation and Dr. Smith is deferring 9% of his compensation. Therefore, Dr. Smith will not only have to make a Top Heavy minimum contribution of 3% of Ella’s gross wages or $900, but Dr. Smith will also have to take a refund of his 401(k) deferrals equal to approximately $6,000, reducing his total contributions to $12,000.

What if Dr. Smith had a Safe Harbor 401(k) Plan? What could he contribute then?

Save More

If Dr. Smith wants to maximize his salary deferrals but is limited to the amount that he can defer due to the lack of participation among rank and file employees (Ella), he can do so by amending his traditional 401(k) plan to be a Safe Harbor 401(k).

Avoid Testing

By choosing to be a Safe Harbor 401(k) plan, Dr. Smith will avoid having to pass the ADP/ACP nondiscrimination test, and in certain instances, can avoid having to make a Top Heavy Minimum Contribution for Ella.

Dr. Smith would share in the Safe Harbor contribution, and if Dr. Smith is older than Ella and the plan is properly designed, Dr. Smith may be able to make a small additional profit sharing contribution for Ella and contribute an additional $29,000 for himself (which would also be deductible by his business).


Safe Harbor plans can be easier to administer for the plan sponsor, particularly because the plan is not required to pass the nondiscrimination test on the salary deferrals and matching portions of the plan. The plan sponsor will have to provide employees with an annual notice describing the Safe Harbor plan and the contributions.

Mandatory Contributions

In order to be a Safe Harbor 401(k) plan, Dr. Smith/ABC Company must make a minimum employer contribution. The contributions choices are as follows:

  1. A 3% Nonelective Employer contribution for all eligible employees (even those who do not make 401(k) salary deferrals) or

  2. A matching contribution only for those who make 401(k) salary deferrals equal to 100% of the first 3% of compensation deferred and 50% of the next 2% of compensation deferred.

All Safe Harbor contributions must be fully vested immediately.

Dollars and “Cents”

For a total contribution amount of $1,500 given to Ella by ABC Company, Dr. Smith is able to increase his total contributions for the year from $6,000 to $53,000 ($35,000 in employer contributions and $18,000 in deferrals). Even if he did not want make the maximum profit sharing contribution for himself, he could make the 3% Safe Harbor minimum contribution, which is equal to the Top Heavy Minimum contribution he would have to make anyway, to himself and Ella. This would increase his total savings for the year from $6,000 to $24,000. Makes “cents” to us!

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