All Things 401(k): Safe Harbors for Plan Sponsors
In my last blog post, we talked about ways that plan sponsors can outsource fiduciary responsibilities. As interesting as it may be, not all plan sponsors fully understand what they are responsible for and liable for. The main functions 401(k) plan sponsors are responsible for include:
• Managing the plan with the sole interest of participants and beneficiaries.
• Ensuring plan fees are reasonable.
• Following the provisions of the plan governing documents.
• Diversifying plan investments.
• Doing all of these things with the care, skill, prudence and diligence.
Aside from outsourcing fiduciary responsibilities, there are contribution and investment safe harbors that can be adopted to protect employers from liability on discrimination testing and participant investment losses.
Contribution Safe Harbors
Electing a safe harbor plan will automatically allow the plan to pass ADP and ACP nondiscrimination testing and top heavy tests, as long as the employer contributions made are only safe harbor contributions. There are three different types of safe harbor contributions that can be used, and each makes sense for a certain set of employee demographics of a company.
1. Safe Harbor Match – there are two types of safe harbor match options that allow the employer to contribute only to participants making employee deferrals.
a. Basic Safe Harbor Match – This formula matches 100% of the first 3% employees defer plus 50% of the next 2%. The maximum employer match would be 4% in this scenario. This option works best for companies with younger owners and key employees with limited income wanting to maximize their employee deferrals without making profit sharing contributions.
b. Enhanced Safe Harbor Match – This formula matches 100% of the first 4% employees defer. This is an alternative to the basic safe harbor match. The main difference is that the employer match cannot increase as employee deferrals increase and matching contributions for highly compensated employees (HCEs) must not be greater for any non-highly compensated employees (NHCEs).
2. Safe Harbor Non-Elective Contribution – Jerry Kalish wrote an article called Take Advantage of ERISA Safe Harbors: They can help penetrate the ERISA fog, he explains that “The employer makes a contribution of 3% (or more) of a participant’s compensation, regardless of whether he or she makes a 401(k) contribution. As with the Safe Harbor Match, the employer’s contribution must be 100% vested.” This option is usually chosen when owners and key employees (over age 50) want to maximize their employee contributions. If the owners and key employees are older than most of the staff, they can receive a 6% profit sharing contribution in addition to the 3% nonelective contribution without having to make additional contributions to the rest of the staff. Employers usually choose this option when they want to provide this benefit to all eligible employees and are likely able to make annual profit sharing contributions.
3. Qualified Automatic Contribution Arrangement (QACA) – This safe harbor option is different, in that an automatic enrollment provision is required and a 2-year cliff vesting schedule is allowed for the employer contribution. In another article called Traditional Safe Harbor 401(k) Plan vs. QACA – How to Choose by Eric Droblyen, he lays out the contribution options for employers to choose from under QACA as:
a. “Basic match – 100% of salary deferrals up to 1% of compensation, 1, plus 50% on the next 5% of compensation (3.5% of
compensation total).
b. Enhanced match – Must be at least as much as the basic match at each tier of the match formula.
c. Nonelective contribution – 3% (or more) of compensation, regardless of salary deferrals.”
Employers usually choose this option when trying to increase employee participation and utilize forfeitures to reduce plan costs due to high turnover in the first 2 years of employment.
These are great options to provide some fiduciary protection for safe harbor 401(k) plans. If you are unsure how to setup your plan or what your current plan provisions are, consult with your advisor and TPA to see what makes the most sense for your company’s 401(k) plan.
Investment Safe Harbors
In addition to contribution safe harbors, there are investment safe harbors that can be utilized to help reduce fiduciary liability when it comes to investment menus, plan design and participant disclosures.
1. 401(k) Deposits – While employee contributions should be deposited with each pay immediately, there is a safe harbor provision that allows seven days for the deposit to be made in plans with fewer than 100 participants. Larger plans do not have a safe harbor provision available but in the DOL rules, it is known that these larger plans must make the deposit within 15 days. By following the DOL rules, this protects the plan sponsor as well.
2. Qualified Default Investment Alternative (QDIA) – When an employee enrolls into a retirement plan, there needs to be an investment selected in order to invest any employee and/or employer contributions. If an employee does not choose an investment, the investment will typically be invested in a default investment. By establishing a Qualified Default Investment Alternative (QDIA), this would protect the plan sponsor from liability when participants assets are invested in a default fund. The default investments typically used are based on age and invested in a target date fund or asset allocation fund. A QDIA Notice would be required to be distributed to all eligible employees at the time of eligibility and annually thereafter.
3. Mandatory Cash-Outs – This is a provision that can be added to the plan design that allows for mandatory distributions of small balances of terminated participants with proper notice. If the balance is below $1,000 a check would be cut and mailed directly to the participant. If the balance is between $1,000 and $5,000, the balance would be rolled into an IRA in the participants name. Employers need to make sure that the notice is provided in advance to give the participant time to elect otherwise. Keep a lookout for more information from SECURE Act 2.0 regarding the $5,000 force out limit increasing to $7,000 in 2024.
4. 404(c) Protection – Under ERISA Section 404(c), if all requirements are met, this would protect plan sponsors of participant-directed retirement plans from any poor investment choices that participants make that lead to losses. The three requirements that must be met include:
a. The plan must offer at least three different investment options with different objectives and/or risk and return
characteristics.
b. Participants must have the ability to be able to change investments at least quarterly.
c. Investment information under 404(a)(5) regulations and investment education must be made available to participants to be
able to make sound investment decisions.
Plan sponsors must make sure to consistently follow these guidelines and provide information on an annual basis to participants regarding the intent to be 404(c) compliant and that fiduciaries are not liable for losses resulting from participant choices.
While these safe harbors are not applicable in all situations, some may be able to help certain plans be more effective and run more efficiently. Plan sponsors should discuss with their advisors and TPA’s to see which safe harbors are currently being utilized and/or if there are ways to provide further fiduciary protection.
JULIA MUNSON
AIF® | Retirement Relationship Manager
Meet Julia, a people-focused life-long learner with several years of experience in the retirement plan industry. Throughout her career, Julia has been committed to maintaining strong client relationships by providing incredible customer service. She is passionate about helping clients define and plan for their retirement goals. Julia’s daily role at the firm energizes and reinforces her commitment to client-focused work.
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