Safe Harbor 401k with Age-Based Profit Sharing: A Win-Win for Small Businesses
by LifeInc Retirement Life,Inc.Retirement ServicesFor many small
businesses comprised of one or several highly compensated employees, and a few
non-highly compensated employees, the Safe Harbor 401k plan may be the best
option if maximizing contributions is a primary objective. Safe harbor plans
effectively remove the barriers of discrimination testing that limits the
amount that can be contributed for highly compensated employees. However, what
if the objective is to be able to contribute the maximum amount allowable under
the tax code? That’s where a combination safe harbor/profit sharing plan can be
the ultimate solution for maximizing the retirement savings opportunities for
business owners and their highly compensated employees.
How Does a Safe Harbor-Profit Sharing
Plan Work?
A Safe Harbor
401k plan is a 401k plan alternative for smaller businesses that seeks to weigh
their contributions more heavily to the owners and/or highly compensated
employees. Essentially, the plan requires a prescribed employer contribution be
made on behalf of all employees and they must be 100 percent vested. With that,
employers can skirt the testing for contributions required of regular 401k
plans – otherwise referred to as a “safe harbor.”
These plans are
well-suited for smaller businesses with less than a half dozen employees which
are weighted more towards the highly compensated. While it’s a significant step
towards increasing their contribution capacity, it still leaves a significant
amount on the table.
Adding an Age-Based Profit Sharing Plan
An age-based
profit sharing plan is generally compared to a defined benefit plan that allows
discretionary contributions. Factors such as age, retirement timeline, and
length of employment are considered as part of the formula for allocating
contributions. So, in businesses where the owners or key employees are
significantly older than the other employees, it can favor the former while not
being discriminatory against the latter. That’s because the contribution amount
is based on projected benefits an employee can expect to receive at retirement.
The closer an employee is to retirement, the higher proportion of employer
contributions he or she can expect to receive.
In a simple example, an owner and his wife, both 48, earning
$250,000 and $100,000 respectively could increase their total contributions
substantially by combining a Safe Harbor 401k plan with an
age-based profit sharing plan.
Under a normal plan rules, the owner and his wife could
contribute up to $18,000 and receive a 4 percent employer match bringing their
total contributions to $27,800 and $22,000 respectively.
By adding a profit sharing component, they could receive an
additional contribution up to 25 percent of their salary up to the 415 limit of $53,000 (2015 limit) and his wife’s total to $35,877. In
doing so; however, they would have to include eligible employees in the profit
sharing contribution.
Based on profit sharing calculations, they would have to make a
contribution of approximately 7 percent on behalf of their three employees earning
$41,000, $36,000 and $32,000. Based on a
total payroll of $109,000, the 4 percent match made under the 401k plan would
amount to just under $4,400. The additional 7 percent profit sharing
calculation would add $7,630, bringing their total exposure to just over
$12,000. However, this additional investment will enable the business owner and
his wife to increase their contributions by more than $40,000. The additional
tax savings realized by the business partially offsets the increased
investment.
In the right situation, the Safe harbor 401k – Profit Sharing arrangement is a
win-win for the business and its employees. And, because profit-sharing
contributions are not mandated, businesses enjoy the flexibility to adjust
their contribution strategy according to its changing circumstances. Although
it does require plan design, administration and reporting, the benefits to the
business, key employees and employees invariably outweigh the costs.
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Created on Oct 2nd 2017 01:49. Viewed 531 times.