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How Does a 401(k) Plan Sponsor Decide Whether to Use Nonelective or Matching Contributions to Satisfy the Nondiscrimination Safe Harbor for Automatic Contribution Arrangements?

EBIA  

EBIA  

QUESTION: We are redesigning our 401(k) plan to use the Code § 401(k)(13) nondiscrimination safe harbor for plans that make automatic deferrals. That safe harbor will also require our company to make nonelective or matching contributions. How do we decide which type of employer contribution to make?

ANSWER: The Code § 401(k)(13) safe harbor for qualified automatic contribution arrangements (QACAs) allows plans to satisfy the actual deferral percentage (ADP) test by requiring automatic deferrals at specified levels (unless participants opt out) and making safe harbor minimum employer contributions for non-highly compensated employees (non-HCEs). The safe harbor minimum employer contributions can be either nonelective contributions or matching contributions, but the plan document must state which will be used. Factors to consider when deciding between the two types of safe harbor contributions include the effect on employee retirement benefits, cost to the employer, and administrative complexity. Here is a summary of issues relating to each type of safe harbor contribution:

  • Nonelective Contributions. Under the nonelective contribution alternative, each eligible non-HCE (including those who opt out of the automatic deferrals) must receive a contribution of at least 3% of compensation. This alternative assures that all will receive a retirement benefit and is easy to explain. It also allows plan sponsors to wait until 30 days before the end of the plan year to decide whether to use the safe harbor for that year. And if your company makes a safe harbor nonelective contribution of 4% (rather than 3%), it could wait until the close of the following plan year to decide. This “wait-and-see” approach requires a plan amendment each year that the safe harbor is used, and it is available only for plans that otherwise use current-year ADP testing and did not provide for safe harbor matching contributions during any part of the year.
  • Matching Contributions. Matching contributions might help dissuade some employees from opting out of automatic deferrals. And, in some circumstances, the cost of providing safe harbor matching contributions—100% match on non-HCE deferrals up to 1% of compensation, and 50% match on additional non-HCE deferrals up to 6% of compensation—can be lower than nonelective contributions. For example, if all non-HCEs made deferrals at a 3% level, the required matching contribution would only be 2% of compensation versus the 3% minimum for nonelective contributions. But if all non-HCEs deferred at the 6% level, the required 3.5% matching contribution would be higher than a 3% nonelective minimum contribution. Which alternative is less costly for your company will depend on workforce demographics and your employees’ saving habits, which may change from year to year. Matching contributions are subject to notice requirements that no longer apply to nonelective contributions. An additional consideration might be the timing of your company’s contributions. Although both types of contributions must be funded within 12 months after the end of the year (under the safe harbor rules) and by your company’s income tax return due date including extensions (under the deduction rules), plan sponsors typically choose to make matching contributions each payroll period, whereas they often wait until the company’s income tax return due date to make nonelective contributions.

For more information, see EBIA’s 401(k) Plans manual at Sections XXII.C (“ADP Safe Harbor Plan Design Requirements”), XXII.E (“ADP Safe Harbor Nonelective Contributions”), and XXII.F (“ADP Safe Harbor Matching Contributions”).

Contributing Editors: EBIA Staff.

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