Safe-harbor sec. 401(k) Plans.

• Author: O'Connell, Frank J., Jr.
• Position: Safe harbor plans

Sec. 401(k)(12) safe-harbor plans first became available to sponsors of Sec. 401(k) plans for plan years beginning in 1999. Until recently, the only IRS guidance on these safe-harbor provisions was. Notice 98-52. This year, however, the Service issued Notice 2000-3, which provides several changes governing Sec. 401(k) safe-harbor plans. Generally, retirement plans that allow employees to make salary deferral contributions (Sec. 401(k) plans) are subject to special nondiscrimination testing, to ensure that highly compensated employees (HCEs) do not benefit to a greater extent than nonhighly compensated employees (NHCEs). Additionally, any employer contributions allocated based on an employee's contribution level (i.e., matching contributions) are also subject to similar nondiscrimination testing. Certain changes in retirement plan laws now allow companies to adopt plan document provisions that eliminate nondiscrimination testing requirements. This could have many benefits, with HCEs maximizing pretax deferrals, employers saving on plan administration costs and eliminating the return of excess contributions.

For plan years beginning after 1998, Notice 98-52 provides that nondiscrimination testing will not be necessary if a plan meets three "safe-harbor" conditions. The three conditions relate to the amount of the employer contribution, the vesting schedule used for employer contributions and an annual employee notification.

To meet the safe-harbor contribution requirement, an employer must make either a matching (allocated to participants based on the Sec. 401(k) deferrals made) or nonelective (allocated to all eligible participants) contribution to all eligible NHCEs. Additionally, the employer may, but is not required to, provide the minimum contribution to all eligible HCEs. For either contribution, the employer cannot require a participant to be employed on the last day of the plan year. This may deter some plan sponsors (who currently have this requirement) from adopting these safe-harbor provisions.

If an employer elects to make a safe-harbor matching contribution, it must be no less than 100% of the first 3% of an employee's deferred compensation, plus an additional 50% match on the next 2% of the employee's deferred compensation. An employer may choose other formulas, such as matching 100% of the first 4% of compensation deferred, as long as the contributions are not less than the contributions the safe-harbor formula would provide...