ABCompany-Safe Harbor Removal

Impacts on the Deferral Contributions of Highly Compensated Employees

Options

One approach is to have all HCEs make deferrals but limit the amount based on the allowable deferral rate. Below illustrates how each HCE would be impacted if all HCEs were allowed to defer, but be limited to the allowable ADP:

One of the major advantages of utilizing a Safe Harbor design is the automatic exemption from the Actual Deferral Percentage (ADP) test. This test determines if there is any discrimination in the amount of elective deferrals allowed in the retirement plan. It compares the percentage of compensation deferred by the highly compensated employees (HCEs) to the percentage of compensation deferred by the non-highly compensated employees (NHCEs). If there is a failure under the ADP test, corrective distributions to HCEs may be required. Under the current Safe Harbor design, HCEs are able to contribute up to the annual deferral limit without concern of corrective distributions because the plan is given an automatic pass on the ADP test. If the Safe Harbor is removed, this automatic pass is no longer available and the plan would be subject to the requirements of ADP testing. This would impact the amount HCEs are able to contribute. The amount HCEs are able to contribute will be based on the ADP of the NHCE population. Below is the 2017 NHCE ADP amount–what would have been an allowable HCE ADP under a non-Safe Harbor design, and the actual 2017 HCE ADP figure.

Employee

Deferral

Participant 1 Participant 2 Participant 3 Participant 4 Participant 5 Participant 6 Participant 7

$1,588.89 ($5,137.15) ($5,667.94) ($3,879.00) ($8,993.75) ($8,483.93) ($11,678.22)

Another option is to cover certain HCEs with a deferred compensation plan outside of the 401(k) and have those individuals forgo 401(k) deferrals in favor of contributions into the deferred compensation plan. In order to keep the plan at or under the HCE ADP amount of 5.23 percent, the HCEs below could stop 401(k) deferrals:

2017 Deferral

Participant 1 Participant 2 Participant 3

$18,000

$17,955.15

2017 ADP for NHCEs

3.23%

$17,785.94 Having these three individual contribute zero allows the other HCEs to defer at the same rate he/she did in 2017 while still allowing the plan to pass the ADP test.

5.23% (under a non-Safe Harbor design)

Allowable ADP for HCEs 2017 ADP for HCEs

9.46%

The results show the plan would fail the ADP test if the Safe Harbor designs were removed and all HCEs continued to defer at the 2017 rate. There are a couple options to address this.

Summary

Removal of the Safe Harbor design will impact the 401(k), specifically the amount HCEs are able to contribute. A deferred compensation plan, covering certain HCEs that forgo 401(k) deferrals, provides an alternative to the current Safe Harbor 401(k) and offers HCEs the ability to continue saving for retirement.