Safe Harbor 401(k)

[Guest Mac Lewis]

Is anybody starting to market and/or comment in the national mass or industry media on the new (1/1/99) safe harbor 401(k)? I would appreciate any news, web page cites, and opinions. Thanks.

[Jon Chambers]

Great question. I have a plan that intends to adopt the 3% across the board safe harbor on or about 1/1/99. How prevalent do people think the safe harbors will be, and which (matching or across the board)will be more popular?

[imchipbrown]

It's gonna be great. Whether match or across the board will probably depend on the participation levels and demographics. I met with an employer yesterday who said (brilliantly, I thought) that an across the board allocation would get the fence-sitters more interested in the plan. He has a lot of low paid employees who probably can't afford to participate at any level. Once they start getting benefit statements (they have individual accounts) and start making investment decisions, they may just ante up a couple of bucks to watch their accounts grow.

[LCARUSI]

I have to differ with Chip - and this is of course only an opinion. I think many/most employers will be reluctant to substantially increase their level of matching (or profit sharing) contributions to satisfy the safe harbor rules. Clients with whom I've spoken have no interest in doing so - even if it would eliminate need for k/m testing.

You know what I think is really unfair? I have a client with a very generous DB plan and a 401(k) Plan (25% match first 6%). This client will not increase the match. They can take no credit for the substantial funding of the DB plan toward the safe harbor requirements of the 401(k) Plan. They would have to curtail/eliminate the DB Plan to take the 401(k) Plan over the safe harbor threshhold. That's not right.

[richard]

I've been wrong before, but, despite the hype, I think the new safe harbor 401k will have limited appeal.

From a cost standpoint, the employer will measure the additional cost of the 3% match over his current level of match, as well as the cost of full and immediate vesting.

Offsetting this will be the consulting (or internal) cost saving of not having to perform ADP/ACP testing and post-year-end corrections; however, this is probably a small administrative cost compared to the cost of the match. (Also, the post-year-end corrections will become easier now that we can use the prior year's nonHCE ADP/ACP levels to determine the current year's maximum HCE ADP/ACPs.)

From an HR standpoint, they will have to decise if the removal of a vesting schedule circumvents the appeal of "the longer you stay with us, the more vested you will become," which HR typically likes.

One key element in the safe harbor's favor is not the cost elimination of the ADP/ACP testing, but rather freeing up the HCEs from any ADP/ACP testing. This can have important HR implications, since HCEs are an important group within the company.

Bottom line -- my best guess is .. probably not tremendous appeal, but it's another design that we ought to analyze for our clients.

(Side note. LCARISI's comment about it being unfair to not be able to take into account the DB cost is correct. Unfortunately, there are many instances where a combination of 401k and DB plans are not "integrated" in the IRS's rules -- in particular, the mandatory disaggregation in the 401(a)(4) rules.)

[Ervin Barham]

I'm finding that the safe harbor design has appeal to smaller employers where participation has not been good or in start-up situations. It should (although I haven't tested it too much) have some appeal in a cross-tested situation.

For the larger employers, the offset of the vesting schedule seems to be a negative.

[LCARUSI]

Ervin -

I'm not sure I understand your comment:

"It should (although I haven't tested it too much) have some appeal in a cross-tested situation."

Could you elaborate? Thanks.

[Ervin Barham]

LCarusi:

Sorry for the vagueness. This is an idea being tossed about from various sources to use the safe-harbor to allow HCE's/owners to defer a higher amount without worrying about ADP/ACP. Since the discrimination test under 401(a)(4) only takes into account the 401(k) amounts in the average benefits portion of the test, "theoretically" this would lower the profit sharing contribution for the HCE, thus making it easier to pass the 401(a)(4) tests as well.

I have not tested it on any live plans, although I see no reason why it should not work.

[Guest boetgerinc]

If an employer adopts a safe-harbor matching formula then there is absolutily no incentive for the employer to have anyone (other than the HCE's) join their plan.

Think about it, if the employer can keep enrollment down, their matching contribution may be less - and they don't have to worry about testing. Do you think any employers will have 401(k) meetings during work time anymore? I know one employer who is going to educate their employees about the benefits of a Roth IRA, so hopefully they will save on their own, outside of the plan (and hopefully not save additional money inside the plan). We all know that not taking advantage of the employer match is crazy - but this is our business. The average particpant really needs educated, which the may no longer get.

In some cases, I really think that the safe-harbour plans may do more harm than good.

Also, if you go with the 3% across the board contribution - does this also satisfy the top-heavy minimum contribution for top heavy plans?

[This message has been edited by boetgerinc (edited 10-16-98).]

[Guest JB2]

I think part of the incentive with the match is to encourage participation to reduce top-heavy percentage. If only your key person participates, then you will have to make an additional contribution.

I believe the 3% nonelective can be used for top-heavy.

[LCARUSI]

I agree with boetgerinc that there will be no incentive for an employer to encourage NHEs to participate.

However, there is a notice requirement and at a minimum the employer must give a notice to all employees before the beginning of each plan year.

[Guest jkirschbaum]

I am an in-house benefits attorney and our admin people have been pushing this option strongly. We have had two subsidiaries that have adopted their own plans. One has gone with the safe-harbor, the other has not. The one that has not wanted to emphasize variable pay. It left some match in the 401(k) but put what would have been needed in the safe harbor to current cash. It drove the admin people crazy! The company was willing to pay the money (the vesting did not bother them), they just wanted to be able to call it a bonus instead of a match.

The other subsidiary thought it was a good idea and adopted it to make life easier.

The point is, the decisions may have nothing to do with costs or other measurable rationale.

[Guest pdall]

safe harbors are the way to go with closely held or small companies whose hce's are limited every single year by poor participation (can't pass k/m test); and therefore can't get their 10K in. i have several clients this will work for - they will be able to go from 4+-% to the full 6.25% and not worry about k/m testing. Since most of these clients make a match anyway, most of them similar in amoutn to what is required in the qmac, then this is easily the best way to go for these clients.

One of the other great benefits is the ability to switch from qnec to qmac from year to year, within the notice guidelines.

[MWeddell]

The notice requirement is not new, but the IRS hasn't issued any guidance yet on the safe harbor contribution issues. They expect to do so before the end of 1998 still. One hopes they'll issue a model notice.

We see little interest in going to the safe harbor contribution among the size clients we talk with (about 500 employees and larger). Reasons for not putting in the contributions are of course the cost and the lower cost of alternatives (more creative allocation of qualified nonelective contributions, splitting the plan into two to improve test results and other testing options, or simply more effective participant communications).

Responding to a different comment on this topic, it's possible that one could use the 3% of pay nonmatching contribution in a floor/offset arrangement with a d.b. plan, but I'd wait until IRS guidance comes out before proceeding with anything too aggressive. Potentially, the 3% of pay contribution can satisfy the safe harbor requirement and serve to other purposes too.

[Guest ndt123]

Most small employers don't offer a match that is equal to the safe harbor (we've looked at 750+ with between 20 and 100 participants).

Also, the previous post made mention of a Notice that allows plans to switch back and forth between qmacs and qnecs. Is this new? As far as I know, no guidance has been released.

[Guest Phil L]

Has anyone seen a sample notice that can be used to satisfy the notice requirements for the 401(k) safe harbor? I would be very interested in seeing what others have done. Thanks.

[Dawn Hafner]

I would also be interested in any sample notifications for safe harbor 401(k) plans. Has anyone seen any?

[Guest pascarp]

We are a fairly large plan sponsor (12,600+ active and 1,500+ retiree/deferred participants) going safe harbor on 1/1/99. Our active participation rate is hovering around 90%. Since our match already met the safe harbor criteria and our turnover is fairly low (<3%), we viewed the move to safe harbor in terms of the "cost" of losing the forfeitures to offset future co. match vs. the projected "benefit" of additional tax-deferral to our mid-level HCEs (who each year complained of being 'penalized' by not being able to reach the $10K limit).

From a PR standpoint, this is viewed as a progressive 'win' for our Corp. Benefits group.

[Dave Baker]

The IRS notice addressing the safe harbor 401(k) plan design is now online on BenefitsLink, at http://www.benefitslink.com/IRS/notice98-52.shtml

[Guest pdall]

I have scanned notice 98-52 and didn't see anything regarding whether the employer can also make additional nonelective contributions if he wants to, if he has elected and made the 3% qnec or the qmac, as required.

It seems that it would not be fair to restrict an employer from contributing the 15% max because he now wants to take advantage of the safe harbor to bypass the adp, (so that he can personally defer 10k).

[MWeddell]

Response to Pdall:

Section V(B)(2) of Notice 98-52 allows nonelective contributions of more than 3% of pay.

Contributing more than the safe harbor match is more complicated if one wishes to preserve the ACP safe harbor. One can't match on more than 6% of pay contributed as elective contributions and employee after-tax contributions. No HCE can get a better matching rate than any similarly situated NHCE. Total discretionary match can't exceed 4% of pay.

[Guest ndt123]

It appears that the notice requies the match to be calculated on annual contributions and annual compensation. For plans that match on pay period by pay period basis, this would require a "true up" match at the close of the year.

Any thoughts?

[Guest kazimer]

I have a client (I'm a benefits attorney) who wants to use the ADP/ACP safe harbor matching contribution starting in 1999 but is running into a problem under Notice 98-52.

The company's plan matches both pre-tax and after-tax employee contributions. Withdrawals are allowed from the employee's after-tax account at any time, but subject to a 6-month suspension from matching contributions.

V.B.1.b. of the Notice says that the rate of matching contributions for any HCE can't exceed the rate for any NCE who has the same rate of elective contributions. Here's where that could pose a problem under the company's plan. Let's say an NCE takes a withdrawal from after-tax and is suspended from matching contributions for 6 months. At the same time this matching suspension is in effect, he can still make pre-tax contributions. So he could be making the same rate of elective contributions as an HCE who is not suspended, with the result that they will have different rates of matching contributions on a plan-year basis. (For purposes of the ADP test safe harbor, rate of matching contributions is defined in the Notice as the ratio of deferrals to matching contributions for the plan year. Rate of elective contributions is the ratio of deferrals to comp for the plan year.)

I could avoid this problem if I eliminated the 6-month suspension for withdrawal of after-tax contributions, but then I'd have a plan qualification problem. The IRS ruling position is that you can't allow an in-service withdrawal from matched after-tax contributions except in case of hardship, attainment of a stated age or after a fixed number of years or if there is a "substantial limitation" like a 6-month suspension. It would be an anti-cutback problem for me to switch from the suspension to using the hardship, age or years conditions instead, so that doesn't seem like a solution.

Can the IRS really have intended this result? Does anybody else have a similar problem?

Mary Ellen Kazimer

[Guest ndt123]

I wouldn't suspend the match on elective deferrals (I'm not sure why they would want to do that anyway), and I would suspend the after tax contributions for the same time period as the match on after tax. Then you can't have a problem.

[Guest kazimer]

ndt123,

I don't think that solution works. I think what you're saying about my example is that if my NCE switches to before-tax contributions after taking the withdrawal (or if he was making before-tax contributions all along), I don't suspend the match at all because the match is on before-tax contributions, not on after-tax contributions. But my problem is that if the guy takes an in-service withdrawal from his after-tax matching account, I am required to impose a penalty. The penalty that the plan was designed to impose is the 6-month suspension of matching contributions. That suspension has to be the consequence of the withdrawal, regardless of whether he's then making before-tax or after-tax contributions. And there's the rub.

If I could, I would drop the 6-month suspension, but I can't because of the plan qualification/anticutback problems I mentioned in my previous post.

I've left a voicemail message with the IRS about this, but I don't know if I'll get a callback at all or in time for the client to decide whether this is going to get in the way of a January 1, 1999 implementation.

Mary Ellen Kazimer

[Guest ndt123]

My suggestion from the original post was that you don't suspend the match as the penalty, but instead suspend the on-going ability to make after-tax contributions (for 6 months).

That way, if you continue to match pre-tax, you won't run afoul of the safe harbor requirements and there is no elimination of an optional form of benefit.

[This message has been edited by ndt123 (edited 11-06-98).]

[LCARUSI]

NDT123 -

I don't believe your suggestion to suspend the participant's right to make after-tax contributions will satisfy the IRS requirement to "impose a substantial limitation on the right of participants to withdraw their own contributions". See rev-ruling 74-55 and 74-56.

Kazimer -

Why don't you impose a24 month holdback on the withdrawal of after-tax contributions. Then, no penalty would be necessary.

[Guest kazimer]

LCARUSI,

Your post is exactly right as to my problem with ndt123's suggestion on the suspension point.

I would definitely switch to the 24-month holdback approach you suggest (or the requirement of attainment of a stated age, etc.), except that I think that then gets me into an anticutback bind. Right now, I let somebody take out contributions made at any time, including in the last 24 months, but I apply the suspension. I don't think I can swap the suspension for the 24-month holdback, because that would deprive participants of the right they have today to withdraw contributions made in the last 24 months. It seems like a real catch-22.

Mary Ellen Kazimer

[LCARUSI]

Mary Ellen -

Two thoughts on this:

1) Impose a 24 month holdback on a PROSPECTIVE basis. I believe this avoids the anti-cutback problem. If you start it on 1/1/99, there would be a holdback of January contributions for a withdrawal in February; there would be a holdback of January and February contributions for a withdrawal in March etc. By 1/1/2001, you have a full twenty four month holdback and there is no need for any match suspension penalty in the plan.

You then go safe harbor as of 1/1/2001.

2) Ask the IRS for guidance. Not many 401(k)Plans allow after-tax contributions. Not a lot of thought, therefore, was given to the complications associated with after-tax contributions. Maybe they would allow you to waive the suspension in the two year period that you are establishing the 24 month holdback enabling you to go safe harbor immediately?

[Guest kazimer]

LCARUSI

Thanks for your latest. #2 gives me something to suggest to IRS if they don't agree that the guidance should be fixed so that my problem isn't one. #1 gives me something to do if I can't convince IRS that there's no problem or that they should OK #2.

Mary Ellen Kazimer

[Guest Laura Millwood]

I need a clarification on safe harbors. Since it must be "hardwired" into your plan document that you are choosing to pass the ADP under tradition rules or safe harbor rules, if the employer realizes well into the year that he cannot afford the match or nonelective that he has chosen, can he amend out of safe harbor status as long as he is within the notice guidelines? We have some clients wary of the safe harbors because they are required contributions.

[LCARUSI]

Laura -

I posted a new thread on this bulletin board - "Discussion with Author of 98-52...". I believe it answers your question.

Len Carusi