New 401(k) Safe Harbor Plans Now Available

Effective for calendar 1999 a new 401(k) plan variant became available which does away with the Average Deferral Percentage ("ADP") test. The ADP test requires that the average contributions of highly compensated employees expressed as a percentage of pay cannot be more than the greater of (i) 1.25 times, or (ii) 2 times (but not more than an added 2 percentage points) more than the average contributions of non-highly compensated employees. The ADP test may keep highly compensated employees from contributing the maximum $10,000 (in 1999) in plans in which participation by non-highly compensated employees is low.

The new safe harbor plan permits all highly compensated employees to contribute the maximum amount allowed if certain minimum contributions are made by the employer to non-highly compensated participants. There are two alternative forms of qualifying employer contributions, (i) matching contributions made only on behalf of employees who make elective contributions, and (ii) employer non-elective contributions made on behalf of all plan participants.

The safe harbor matching contribution is an amount equal to 100% of an employee's elective contribution up to 3% of the employee's compensation and 50% of the amount of an employee's elective contribution which exceeds 3% of the employee's compensation but does not exceed 5% of the employee's compensation, i.e., a maximum 4% match. The safe harbor non-elective contribution is an amount equal to 3% of the compensation of each employee eligible to participate in the plan regardless of whether the employee actually makes elective contributions.

The employer minimum contributions must be fully vested when made and cannot be distributed earlier than separation from service, death, disability, certain sales of subsidiaries or business assets or attainment of age 59=. These contributions are not eligible for hardship distributions.

Of particular interest is an employer's ability to make the minimum safe harbor contributions to another plan besides its 401(k) plan. For example, if an employer now sponsors both a 401(k) plan and a money purchase pension plan, and it makes at least a 3% contribution to the money purchase plan, it could take credit for the contribution under the 401(k) plan and thus dispense with ADP testing. Of course the money purchase plan would have to be amended to provide for full vesting, etc., at least with respect to the 3% contribution in order to qualify under the 401(k) safe harbor. This could be an attractive way to increase tax shelter opportunities for highly compensated employees.

In order to take advantage of the 401(k) safe harbor, you must amend your 401(k) plan no later than the end of the plan year beginning in 1999 and generally provide 30 days' notice to the participants of the safe harbor contribution basis.