A 401(k) retirement savings plan allows a worker to save for retirement and have the savings invested while deferring current income taxes on the saved money and earnings until withdrawal.  The employee elects to have a portion of his or her wages paid directly, or “deferred,” into his or her 401(k) account. This deferment is also known as a “contribution.”

401(k) plans are mainly employer sponsored plans; the employer can, as a benefit to the employee, optionally choose to “match” part or all of the employee’s contribution by depositing additional amounts in the employee’s 401(k) account or simply offer a profit sharing contribution to the plan. In participant-directed plans (the most common option), the employee can select from a number of investment options, usually an assortment of mutual funds that emphasize stocks, bonds, money market investments, or some mix of the above.  The employee can generally re-allocate money among these investment choices at any time.

Comparison chart

401(k)	Safe harbor 401(k)
Eligible employer
All taxable businesses Tax-exempt organizations (No government entities)	Same as 401(k)
Contribution types
Traditional before-tax contributions Roth after-tax contributions	Same as 401(k)
Who must be covered(Plan sponsors may choose more flexible requirements to include younger employees and those with fewer hours of service.)
Any employee with 1,000 hours of service within one year and who is age 21 or older; can exclude certain employees	Same as 401(k)
Maximum total plan contribution that the employer may deduct
25% of total eligible payroll (maximum eligible pay per participant is $245,000 in 2010) plus the amount of elective deferrals contributed	Same as 401(k)
Maximum annual allocation to participant’s account (employer and participant contributions)
100% of participant’s total pay or $49,000 in 2010, whichever is less.* Participants 50 years or older may contribute an additional $5,500 in 2010.	Same as 401(k)
Maximum annual participant deferral (cannot exceed 100% of pay)
Up to $16,500 in 2010 Salary deferrals into other qualified plans count toward the limit.  Both pretax and Roth after-tax contributions count toward the limit.	Same as 401(k)
Catch-up provisions for participants 50 years and older
Up to $5,500 for 2010. Both pretax and Roth after-tax contributions count toward the limit.	Same as 401(k)
Required employer contribution
Discretionary, unless the plan is top-heavy	One of the following: Basic match Enhanced match Nonelective contribution Qualified Automatic Contribution Arrangement (QACA) plans — Employers must match employee contributions at a certain level or make a minimum contribution of 3% for all eligible employees.
Vesting (participant contributions are always 100% vested)
Vesting schedules available	Immediate 100% vesting on safe harbor contributions QACA plans: 2-year vesting schedule
Testing required
Top-heavy: Yes ADP: Yes ACP: Yes 415: Yes	Top-heavy: No (if safe harbor conditions are met) ADP: No (if safe harbor conditions are met) ACP: No (if safe harbor conditions are met) 415: Yes
Participant loans
Yes	Same as 401(k)
Deadline for plan establishment
The plan must be signed by the last day of the plan year but not later than the commencement of employee contributions	First day of plan year
Disclosure
Summary Plan Description	Summary Plan Description Annual notice of contribution intent and specific plan provisions
Advantages
Contributions not mandatory — employer can contribute some years and not others Customized plan design permitted Employer contributions may be subject to a vesting schedule Forfeitures can offset employer contributions or provide extra allocations Loans permitted Can restrict participant access to contributions May maintain other plans Available to any size employer, but may not be suitable for small companies	Existing 401(k) plans can add safe harbor options by plan amendment Highest limits for employer and participant contributions ADP testing not required ACP testing only required if employer match exceeds 6% of employee’s eligible compensation Generally less administrative expense and responsibility than non-safe-harbor 401(k)s Customized plan design permitted Loans permitted Can restrict participant access to contributions May maintain other plans Available to any size employer
Disadvantages
Subject to ADP and ACP testing Generally higher administrative expenses than safe harbor 401(k)s More administrative responsibilities Not available to state and local governments	Employer contributions are mandatory Safe harbor contributions 100% immediately vested (no forfeitures available to offset future employer contributions) More administrative expense and responsibility than SIMPLEs, SEPs Not available to state and local governments Must notify participants annually of contribution intent and provide annual plan summary 2-year vesting schedule for QACA plans
Sponsor considerations
401(k) plans might appeal primarily to larger employers who: want highest limits for employer and participant contributions want vesting schedule need competitive plan options to attract and retain key employees expect good participation by non-highly-paid employees want customized plan design need loans to encourage participation can tolerate higher administrative expense want to retain flexibility with respect to matching contributions	Safe harbor 401(k) plans might appeal primarily to any size employer who: has trouble passing ADP/ACP tests in existing non-safe-harbor 401(k) expects low participation by non-highly-paid employees doesn’t want responsibilities and expense of testing wants highest limits for participant contributions has consistent cash flow to make the mandatory contribution every year wants the ability to budget for the contribution every year

^*The defined contribution annual additions limit is effective for limitation years ending in the calendar year.

Qualified Automatic Contribution Arrangement (QACA)

The QACA provision offers a new safe harbor for automatic enrollment plans that is more generous to the plan sponsor than the current ADP/ACP safe harbor provisions.

A QACA plan requires the following:

• Unless an eligible employee makes a deferral election, the rate of deferral for automatically enrolled employees must be at least 3% of pay until the end of the participant’s next plan year, 4% for the following year, 5% for the next, and 6% thereafter. The rate cannot exceed 10%.
• Employers must either match employee contributions at a rate equal to 100% of the first 1% deferred plus 50% of the next 5% deferred, or make an employer contribution of at least 3% for all eligible employees.
• If a Qualified Default Investment Alternative (QDIA) is used, a participant is allowed to request a permissible withdrawal of his or her contributions without penalty within 90 days of the date the first contribution is withheld from his or her paycheck.

Employees who can be excluded from the plan

• Union employees — May exclude union employees whether or not they are covered under a separate retirement plan, as long as retirement benefits were the subject of good-faith bargaining.
• Nonresident aliens with no U.S. source income.
• Other exclusions — Can exclude other employees, such as sales representatives, leased employees, hourly paid employees, etc. Any of these exclusions subject the plan to coverage testing. In addition, care should be taken not to inadvertently impose an age or service requirement that would disqualify the plan.

Tests that can be applied to 401(k) plans

Top-heavy test:
If the total value of the accounts of all key employees is greater than 60% of the total value of the accounts of all employees the plan is top-heavy. A mandatory minimum employer contribution equal to 3% (or the highest allocation made to key employees, if less) must be made to the plan.

ADP (Actual Deferral Percentage) test:
This test uses an average percentage of the non-highly-compensated employees’ deferral to limit the amount the highly compensated employees may defer on average. Both pretax and Roth after-tax contributions are taken into account for this test.

ACP (Actual Contribution Percentage) test:
This test uses an average of the matching contribution made to non-highly-compensated employees to limit the matching contribution to highly compensated employees on average.

415 test:
This section of the Internal Revenue Code limits the amount of contributions and forfeitures (together referred to as annual additions) that can be allocated to a participant’s account(s) in one year. The limit is 100% of total compensation or $49,000 in 2010, whichever is less.

Safe harbor 401(k) employer contribution options

Basic match:
100% of participant contributions up to 3% of pay, plus 50% of participant contributions up to the next 2% of pay.

Enhanced match:
100% of participant contributions, but not less than 4% or more than 6%.

or

A formula based on several different factors.

Nonelective contribution:
3% of pay for all eligible employees, including those who do not contribute.

---

The above information is general in nature and is not intended as legal or tax advice. Along with our help, you should seek the advice of your tax consultant and/or attorney.