Many small businesses are recognizing that a Safe Harbor 401(k) is a stress-free way to provide their employees with access to retirement savings. Though most companies know that offering a 401(k) makes it easier for their employees to build a nest egg, it can be time-consuming to research why some plans are a better fit than others. Another thing to keep in mind: The Internal Revenue Service (IRS) has nondiscrimination tests for 401(k) plans to make sure that plans fairly benefit all employees, not just those with higher salaries. Because, in many cases, safe harbor plans satisfy these tests, some employers are taking a closer look at how they work.
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What you’ll learn
What you’ll learn
Key takeaways
- A Safe Harbor 401(k) can help small businesses avoid most annual nondiscrimination testing requirements.
- Employers must make required contributions, either through a match or a non-elective contribution.
- Safe Harbor plans come with specific timing and employee notice requirements.
- Offering a retirement plan can support recruiting, retention, and potential tax advantages.
But how do you know that this type of plan makes sense for your organization? To help business owners understand all that’s involved, this guide explains how Safe Harbor 401(k) plans work, their differences from traditional savings plans, and how to set one up.
Why offer a 401(k) to your employees?
Including access to retirement savings in your company’s benefits package can have positives for both your employees and your company.
Team building and recruitment
Offering your employees the chance to start building up savings for retirement can make you a more appealing employer to job seekers. In fact, OnPay’s research found that a retirement savings plan is one of the perks that employees have at the top of their wish lists. In addition to helping you attract talent, a 401(k) can help provide peace of mind for your top-performing employees, as retirement approaches, many Americans feel less than confident that they’ll have enough saved.
Considerations for compliance
Did you know that a growing number of states require employers to provide their employees access to a retirement savings plan (whether it’s state-sponsored or through a private company)? For example, in California, if an employer has just one employee on the payroll, there are laws that say it’s a must to offer access to a savings program. And other plans are in the works in states like New Jersey and New Mexico. We should point out that there can be penalties that come with ignoring mandates, which amount to more than just a slap on the wrist. These vary from $250 to $750 per employee, depending on the state. It’s a good idea to research the rules where you do business to see if there’s a program in place or any that are in the planning stages.
Tax benefits for employers
By setting up a new 401(k) plan, there are several tax advantages that businesses may benefit from. For example, employers could be eligible for up to $5,000 in tax credits over the first three years, and those credits can go as high as $16,500 thanks to the SECURE Act. This can go a long way toward offsetting the costs of plan administration. Additionally, employer contributions to the plan may be tax-deductible as a business expense on your company’s federal income tax return. Note: it’s always a good idea to consult a tax professional about any tax credits or deductions your business could be eligible for.
Next, let’s find out more about what these plans are and how nondiscrimination testing is part of the equation.
What is a Safe Harbor 401(k) plan?
Simply put, a Safe Harbor 401(k) plan automatically satisfies most nondiscrimination testing (more on this below). This type of 401(k) includes certain built-in elements that help employees save for retirement by requiring companies to contribute to their employees’ 401(k) accounts. By taking steps to encourage more employees to participate, the IRS offers employers “safe harbor” from certain nondiscrimination testing processes and the consequences of failing these tests.
What are nondiscrimination tests, and how do they affect a 401(k) plan?
Uncle Sam has established a series of what it calls nondiscrimination tests designed to measure whether a 401(k) plan unfairly favors highly compensated employees. The takeaway? Their purpose is to make sure that all employees are able to benefit from the plan their employer offers.
What do the tests look for?
The IRS requires three main types of nondiscrimination tests to ensure that 401(k) plans benefit both owners and employees.
- Two of these tests compare how highly compensated employees (HCEs) and all other employees use the company’s 401(k)
- The third looks at how much of all plan assets are owned by key employees at a company
Here’s a brief overview of each.
Actual deferral percentage
The Actual Deferral Percentage (ADP) test measures what percentage of their income your HCEs contribute to their 401(k), compared to rank-and-file employees.
Actual contribution percentage
The Actual Contribution Percentage (ACP) test is similar, but it compares employer matching contributions to HCEs with everyone else.
Top-heavy test
A third, the top-heavy test, looks at individuals the IRS defines as “key employees” and measures the value of the assets in their 401(k) accounts, compared to all assets held in the 401(k) plan.
If an employer’s plan fails any of these tests, it means dealing with some administrative hassle, potentially expensive corrections, and the possibility of having to refund 401(k) contributions.
Safe Harbor 401(k)s are growing in popularity because they can generally help companies avoid the uncertainty surrounding annual nondiscrimination testing.¹
Setting up a Safe Harbor 401(k) plan
If you read through each of the tests above and think that they are more complicated than you expected, a Safe Harbor 401(k) may be a better fit. There are two types of Safe Harbor 401(k) plans, each with different requirements, but both lead to the same results regarding annual testing.
- A traditional Safe Harbor 401(k) plan has requirements related to contributions, distributions, vesting, and participant notifications
- A Qualified Automatic Contribution Arrangement (QACA) combines the Safe harbor provisions with automatic enrollment. It allows for a lower match and the ability to apply a vesting schedule. You can find more information about the automatic enrollment and automatic escalation portion of the QACA here
Safe Harbor plans require that employers contribute to an employee’s retirement 401(k) account in one of two forms: a match or nonelective contribution. This requirement is important because it can help increase savings. According to a recent survey from the US House Committee on Ways & Means, more than half of Americans feel they haven’t saved enough for retirement.
In exchange for plans to automatically satisfy most nondiscrimination testing, there are some rules companies need to follow. Let’s see what’s required when setting up these plans so that business owners can hit the ground running.
Contribution requirements for a Safe Harbor 401(k)
So, what should you be paying close attention to when considering this type of retirement savings program? The main requirement for a Safe Harbor 401(k) is that the employer must make contributions to it. In a traditional Safe Harbor 401(k) plan, those contributions must vest immediately. In a QACA plan, contributions can be subject to a maximum of a 2-year vesting schedule. Contributions can take three different forms, the first two of which are matching, which means that employees must defer funds to their accounts in order to receive contributions. The third option requires the employer to make a contribution, even if employees don’t defer any of their income into their plan.
Here are examples of the different contribution formulas:
Basic matching
- Traditional: The company matches 100% of all employee 401(k) contributions, up to 3% of their compensation, plus a 50% match of the next 2% of their compensation
- QACA: The company matches 100% of all employee 401(k) contributions, up to 1% of their compensation, plus a 50% match of the next 5% of their compensation
Enhanced matching
The company matches at a level that is at least as good as the basic matching formula (maximum limits may apply depending on ACP Safe Harbor status)
- Traditional example: 100% of all employee 401(k) contributions, up to 4% of their compensation
- QACA example: 200% of all employee 401(k) contributions, up to 2% of their compensation
- Nonelective contribution: The company contributes at least 3% of each employee’s compensation, regardless of whether employees make contributions
Contribution limits that business owners should know
For 2026, the basic employee deferral limits for a Safe Harbor plan are the same as any employer-sponsored 401(k):
- $24,500 per year for participants under age 50
- $32,500 when you include catch-up contributions for employees over age 50 or older
Here are the limits from 2025:
- $23,500 per year for participants under age 50
- $31,000 when you include catch-up contributions for employees over age 50 or older
There’s another perk: With Safe Harbor provisions in place — and less to worry about when it comes to nondiscrimination testing — owners and highly compensated employees can truly max out their deferrals. The takeaway? It means that your employees will be able to take full advantage of their contribution limits.
Now that we know more about how much individuals can contribute, let’s find out some important set-up dates to keep in mind.
Deadlines for Safe Harbor plans
Safe Harbor plans have important timing requirements. Here’s a quick overview of how adoption timing affects contributions and notice obligations.
| Scenario | When it must be adopted | Notice required? | Contribution impact |
| New Safe Harbor plan | Before the start of the plan year | Yes (30–90 days before plan year) | Applies to entire plan year |
| Add Safe Harbor match | Generally effective at start of future plan year | Yes | Based on match formula |
| Add 3% nonelective | Before specified plan-year deadline | Yes | 3% for entire plan year |
| Add late nonelective | Through end of following plan year | Yes | At least 4% |
Plan amendments typically take effect at the beginning of a future plan year. Because amendments and required employee notices must be completed in advance, it’s important to coordinate with your plan administrator well before the new plan year begins.
Small businesses understand retirement plan appeal
In an OnPay survey, nearly 40% of small business owners said that they have thought about offering team members the opportunity to build their savings through an employer-sponsored retirement plan.
Source: 2024 small business observations
Important dates for existing plans — Safe Harbor nonelective contributions
If you want to add a Safe Harbor nonelective provision to an existing 401(k) to take advantage of Safe Harbor status for the current plan year, you may generally do so before the 30th day before the close of that plan year, provided you contribute at least 3% of eligible compensation for the entire year.
After that point, a Safe Harbor nonelective contribution may still be adopted through the end of the following plan year, but the required contribution increases to at least 4%.
Employee notice requirements
Annually, each eligible employee must be notified in writing about their rights and obligations under the plan if the plan includes matching or automatic enrollment features. Notice must be given within a reasonable amount of time — at least 30, but not more than 90 days — before the beginning of the plan year.
Making mid-year changes to a Safe Harbor plan
If you are a business that already offers a Safe Harbor 401(k) plan and want to make changes, there are special rules to follow. All the details for mid-year changes are included in IRS Notice 2016-16, but these are the basic IRS requirements:
- Give employees an updated Safe Harbor notice that describes any changes. Notice should be given 30 to 90 days before the changes go into effect
- Give each notified employee at least 30 days to change their cash or deferral election
- A combined notice may be provided
Once you have satisfied the notice rules above, you may be able to make changes to certain aspects of the plan. For example, increasing future Safe harbor nonelective contributions from 3% to 4%, or changing the plan entry date for eligible employees from quarterly to monthly.
However, several types of changes are not permissible during the year. Review the rules carefully if you wish to amend your plan.
Does a Safe Harbor 401(k) plan make sense for my business?
In general, Safe harbor plans are a good choice for companies that do any of the following:
- Plan to match employee contributions anyway
- Worry about passing nondiscrimination testing
- Fail the ADP, ACP, or top-heavy tests
- Have low participation among NHCEs and non-key employees
- Care deeply for the well-being of their employees
In terms of pros and cons, the biggest downside to offering a Safe harbor plan is the cost of the contributions you will need to make. If all employees participate, it’s possible that they could increase a business’s payroll by 3% or more. But many companies think the upside outweighs the cost. Offering a Safe Harbor 401(k) plan can result in happier employees, tax savings, and greater certainty that a plan won’t fail nondiscrimination tests.
Disclaimers:
The information provided herein is general in nature and is for informational purposes only. It should not be used as a substitute for specific tax, legal and/or financial advice that considers all relevant facts and circumstances. You are advised to consult a qualified financial adviser or tax professional before relying on the information provided herein.
¹ Safe Harbor 401(k) plans generally automatically satisfy Top Heavy requirements, except for plan years in which the employer makes discretionary contributions (such as profit-sharing contributions) in addition to Safe Harbor contributions.
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Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.