Benefit Plan Blog

In a prior posting, I indicated that there were several important due dates for employee benefit plans between now and year end. One of which is the December 1 due date for calendar year plans to distribute safe harbor notices for 2006.

A safe harbor plan can be an effective tax planning technique for closely-held companies. For the price of a safe harbor employer contribution, the discrimination tests that apply to employee deferrals (ADP) and matching contributions (ACP) are deemed satisfied and, thus, the Highly Compensated Employees (HCEs) may make the maximum allowable deferral of compensation without the need for the plan to pass the discrimination tests. In 2006, the maximum deferral to a 401(k) plan will be $15,000. In addition, if the participant is over age 50, or will attain age 50 during 2006, a catch-up contribution of $5,000 may also be made.

An employer may satisfy the safe-harbor by making a contribution of at least 3% or more of compensation. Generally, the 3% NEC must be provided to all employees eligible to make elective deferrals to the plan.

Alternatively, an employer may make one of two types of a safe harbor matching contribution. The first is a 100% match on the first 3% of compensation 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. The enhanced matching contribution rate may not increase as the percentage of deferrals goes up, and the rate of match for the HCE group may not exceed the rate of match for the nonhighly compensated employee group (Non-HCEs).

Here are a few key points about safe harbor contributions:

• No Allocation Requirements may be imposed, such as, a 1,000 hour or last-day requirement.
• The contributions must be 100% vested.
• The 3% contribution can be used to satisfy Top Heavy minimum contribution and can be used towards satisfying cross-testing gateway.
• The matching contribution can used to satisfy a Top Heavy minimum contribution.

Safe harbor plans are not for every employer. The decision to use the safe harbor technique should be based on the employer's goals, plan design, contribution sources and demographics.