Some retirement plans, such as 401k plans, provide a surefire way for employers to minimize the hassle and paperwork associated with Internal Revenue Service compliance. The IRS mandates that all qualified, employer-based retirement plans comply with rigid nondiscrimination rules to maintain their status as retirement plans. The safe harbor rule ensures that employers follow the law without having to adopt complex accounting in-house.
A safe harbor contribution is a contribution amount made by the employer into an employee's retirement account. The safe harbor rules for contributions do not require employers to use complex calculations to ensure compliance with nondiscrimination rules. Instead, the employer makes a flat contribution to the employee's account that is based on contributions made by the employee or constitutes a percentage of the employee's annual compensation.
Safe harbor contributions allow simplicity in contributions for the employer. Safe harbor contributions may be made as a dollar-for-dollar matching contribution up to 3 percent of employee compensation, then 50 cents for every $1 of employee contribution on the next 2 percent. Finally, no matching contributions are allowed on more than 6 percent of an employee's compensation. Alternatively, the employer may make a flat contribution of no less than 3 percent of the employee's total annual compensation regardless of employee contributions.
While there is some flexibility in terms of contribution methods, the contributions that must be made to the plan are quite rigid. The employer must make all contributions according to one of the two formulas set forth by the IRS. Failure to make contributions according to the safe harbor rules will require the employer to follow the IRS' nondiscrimination testing, which involves more complex calculations to keep the retirement plan open.
Even though safe harbor contributions require that the employer follow rigid but simplified rules, the employer should still consider using safe harbor contributions. All contributions made by the employer are 100 percent vested with the employee. This means the employee may leave the plan and take the contributions at any time. While this might pose a risk of employees leaving before a certain amount of service has been completed, it may also bolster employee moral knowing that the employer is generous enough to make such contributions in the first place.