Retirement Plan Help for Business Owners

Jaron Carmichael, CFP®, AIF®

Director of Retirement Group, Wealth Advisor


A safe harbor 401(k) plan or cash balance plan can allow business owners to save even more toward their own retirement.

Safe harbor 401(k) plans and cash balance retirement plans offer advantages for business owners and employees

Labor Day not only marks the unofficial end of summer, but also serves as a reminder for organizations to get busy if they intend to revise their company-sponsored retirement savings plans for the coming year. Depending on the specific type of plan offered, businesses may need to notify employees starting in early October about any changes set to take effect in January 2023, especially since businesses are required to notify their employees between 30 to 90 days prior to the start of the new plan year.

Beyond meeting the standard IRS notification requirements during this time window, business owners may also be able to dramatically increase their own retirement contributions by changing the type of company-sponsored retirement benefit they provide. A safe harbor 401(k) plan and a cash balance plan are two options that offer distinct advantages for a business’s top earners as well as its rank-and-file employees.


How a safe harbor 401(k) works

Changing from a traditional 401(k) plan to the safe harbor option enables business owners and other highly compensated employees (HCEs) to maximize their retirement plan contributions without being constrained by the average contribution rate among lower-paid employees. This is possible because the safe harbor option eliminates a key IRS non-discrimination testing requirement.

Businesses offering a traditional 401(k) plan must undergo annual government testing to ensure that employer matching contributions do not discriminate against lower-paid employees in favor of the owners and other HCEs who earn more than $135,000 per year.

HCEs who earn more than $135,000 per year often have their contributions limited based on what non-HCEs contribute. For example, if contributions of non-HCEs average 3%, a highly compensated employee can only be allowed to contribute 2% more than that average, or 5% of pay instead of contributing up to the IRS limit.

If a plan fails IRS non-discrimination testing, the business owner must either return a portion of the HCEs’ contributions back to the HCEs or make additional contributions for the lower-paid employees. The company also may owe a 10% excise tax if it fails to take corrective action promptly.

A safe harbor 401(k) plan automatically passes most non-discrimination testing, which relieves a business of a potential administrative burden and frees its HCEs to defer the maximum allowable annual contribution—up to $27,000 for those age 50 and older1—into their 401(k) account. Also, the business may qualify for additional tax benefits by creating a new 401(k) plan.

There are several ways that an employer can satisfy the requirements of a safe harbor 401(k) plan. One is for the employer to contribute a minimum of 3% of all employees’ salaries to every eligible employee’s 401(k) balance, whether an employee is also contributing their own funds to the plan or not. Also, 100% of employer contributions to a safe harbor 401(k) plan are immediately vested, whereas a traditional 401(k) plan may have a vesting schedule of several years.

Employers who want to convert a traditional 401(k) plan to a safe harbor plan and gain the benefits for the 2022 calendar year must complete the change no later than November 30.


How a cash balance plan works

For business owners who have even more aggressive retirement savings goals, a cash balance plan can allow them to contribute up to $258,000 per year, depending on their age. This type of plan is entirely employer-funded and can be set up in ways that primarily benefit the business owner.

Typically, each employee participant in a cash balance plan receives a yearly pay credit—commonly 5% to 8% of the employee’s salary—along with a fixed- or variable-rate interest credit, and these contributions accrue in each person’s account. The plan then pays a defined benefit to the employee upon retirement, either in a lump sum or as an annuity.

A cash balance plan allows business owners to deduct their contribution from profits as a business expense and let the amount grow tax-deferred. Also, every business owner and employee can be categorized individually in the cash balance plan when defining the amount of their respective retirement benefit.

Business owners can adopt and fund a cash balance plan retroactively, as long it is completed by the business’s extended tax filing deadline. For example, if your extended business tax filing deadline is September 15, you have until September 15, 2022 to make cash balance plan contributions for the year 2021. We recommend starting the set-up process with your actuarial firm about a month before your tax filing deadline to allow time to set up the plan and calculate the recommended amount of contributions.


An experienced financial advisor can help

With some preparation and a modest boost in the employer contribution to your company’s retirement plan, you can multiply the long-range benefits available to you as the business owner.

Your retirement plan administrator will manage the process of changing to a safe harbor 401(k) plan or creating a cash balance plan. However, either option is likely to require some intricate financial considerations that may stretch beyond the administrator’s core expertise.

Mercer Advisors has a team of retirement plan specialists who can help you weigh the benefits and costs, answer questions, and make a choice that meets the needs of your business as well as its employees. We also offer comprehensive support that encompasses the investment strategy, administrative tasks, regulatory requirements, and other components of your business retirement plan. Learn more about our Retirement Plan Services for Businesses.

Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.

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