Small Plans Love Safe Harbor 401(k)

An Employee Fiduciary study of 2,767 small business 401(k) plans for which the firm provides ERISA compliance services found that 68% of those plans use a safe harbor 401(k) plan design to avoid annual ADP/ACP and top heavy nondiscrimination testing.

While I would think that’s on the high side and maybe it’s based on the clients that Employee Fiduciary handles, it’s not surprising that so many small plans decide to use safe harbor 401(k) plan. Lets face facts about small plans, their employee demographics support safe harbor because there tends to be a big financial divide between the highly compensated employees who are owners and the rank and file employees. If there is such a huge disparity in compensation between highly paid employees and lower paid, that means less deferrals by the lower paid will result in compliance testing failures. That’s why safe harbor 401(k) plan design is so attractive.

To the absolute surprise of no one who had 401(k) plan knowledge, the study stated that only 8.71% of these plans use automatic enrollment. That is absolutely no surprise because a safe harbor plan design that allows a plan sponsor exemption from a few compliance tests such as the Actual Deferral Percentage test makes one of the needs to automatically enroll employees, moot. Why is it moot? One of the reasons to implement automatic enrollment is to help with the ADP test by “forcing” lower paid employees into the plan to hike up their deferral percentage rate.

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