Every October, the IRS comes out with the annual retirement plan limits. Some of these limits provide in part; the maximum individual contribution to Solo 401k, 401(k), 403(b) or 457 plans; the maximum compensation taken into consideration for retirement plan allocations and deductions; and the social security limits.

Investment representatives and retirement service providers will be hailing the new limits as an opportunity for employees to save more money in their retirement plans on a tax deferred basis. Following that advice may be a mistake for highly paid employees and could cost their employer additional fees.

Following the advice, highly compensated employees, with higher discretionary income levels, would increase their contributions. The non-highly compensated employees, with little discretionary income, will maintain their contributions at the current levels. The net result is a failed Average Deferral Percentage test with the subsequent refunds to the highly compensated and additional employer fees.

Instead of touting the new plan contribution limits alone, investment representatives need to include the ”Safe Harbor” plan design benefits with them. Adopting a safe-harbor 401(k) plan design permits an employer to avoid discrimination testing of the rates of employee elective de¬ferrals and/or employer matching contributions (ADP / ACP test¬ing). The benefit for avoiding testing is maximized contributions for the highly compensated.

Generally, there are two types of safe-harbor designs.

One type is the safe-harbor non-elective design of 3% of compensation. Generally, a 3% contribution is provided to all employees eligible to make elective deferrals to the plan. The guaranteed contribution requires that a 3% employer contribution be made each plan year, unless the employer amends the plan and removes the provision before the start of the new plan year. The 3% is 100% employee vested.

The other type of safe-harbor design is a matching contribu¬tion. There are two options from which to choose, the basic or the enhanced match. The basic safe-harbor matching contribution is defined as a 100% match on the first 3% deferred and a 50% match on deferrals be¬tween 3% and 5%. Alternatively, the employer may choose an enhanced match¬ing formula equal to at least the amount of the basic match; for example, 100% of the first 4% deferred. Safe-harbor 401(k) plan provisions may not be added to an exist¬ing 401(k) plan in the middle of a plan year. Instead, the plan must be timely amended to add the safe-harbor 401(k) provi¬sions for the next plan year.

In an exception to the timing requirements for giving the safe¬harbor notice, a new 401(k) may adopt a safe-harbor design at the same time that the plan is established, assuming the notice is provided simultaneously. There must be at least 3 months remaining in the plan year to make elective deferrals for a plan to use this provision. An existing profit-sharing plan that is amended to add a 401(k) feature is eligible to use this rule.