If you sponsor a traditional 401(k) plan for your employees, you might be able to boost your own retirement contributions substantially by switching to a different type of retirement benefit. Below are two options for retirement plans that offer distinct advantages over the traditional 401(k) for a business’s top earners as well as its rank-and-file employees.
When contemplating a change to your business’s retirement savings plan for the upcoming year, keep in mind that you’ll want to review your options prior to summer’s end. Depending on the specific type of plan offering, you may need to notify your employees starting in early October about any changes set to take effect in January. Businesses are required to notify their employees between 30 to 90 days prior to the start of the new plan year.
1. Safe harbor 401(k) plan
Switching from a traditional 401(k) plan to a safe harbor option allows you, as the owner, and other highly compensated employees (HCEs) to maximize your retirement contributions without being constrained by the average contribution rate of lower-paid employees. The safe harbor option eliminates a key IRS non-discrimination testing requirement, ensuring that HCEs can fully leverage their contribution limits.
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 owners, HCEs, and officers.
| 2024 HCE minimum salary:1 | $155,000 |
| Average employee deferral rate:2 | 7.4% |
| 2024 Maximum deferral:3 | $23,000 or $30,500 (including $7,500 catch-up) for those age 50 and older |
HCEs 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, you must either return a portion of the HCEs’ contributions back to the HCEs or make additional contributions for the lower-paid employees. You may also owe a 10% excise tax if you fail to take corrective action promptly.
A safe harbor 401(k) plan automatically passes most non-discrimination testing, which relieves you of a potential administrative burden and frees HCEs to defer the maximum allowable annual contribution into their 401(k) account. Also, your business may qualify for additional tax benefits by creating a new 401(k) plan.
There are several ways that you can satisfy the requirements of a safe harbor 401(k) plan. One is to contribute a minimum of 3% of all employees’ salaries to every eligible employee’s 401(k) balance, regardless of whether an employee is also contributing their own funds to the plan. 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 following calendar year must notify participants no later than December 1, 2024.
These statistics from a 2024 Vanguard report show the percentage of plans with safe harbor according to plan size:
| Vanguard defined contribution plans permitting employee-elective deferrals | |
| Plan size (number of participants) | Percentage of plans with a safe harbor design |
| <500 | 28% |
| 500-999 | 29% |
| 1,000-4,999 | 29% |
| 5,000+ | 38% |
| All plans | 29% |
Source: Vanguard 2024
2. Cash balance plan
If you have even more aggressive retirement savings goals, a cash balance plan can allow you to contribute up to a maximum amount depending on your 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 — say, 5% or the percentage you’re matching — 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 you to deduct your 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.
You 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 to make cash balance plan contributions for the previous year. 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.
Take advantage
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 and employees. We also offer comprehensive support that encompasses the investment strategy, administrative tasks, regulatory requirements, and other components of your business retirement plan. If you’re a client and want to find out more, contact your wealth advisor.
If you’re not a Mercer Advisors client and want to explore our retirement plan services for businesses or discuss a comprehensive wealth management plan for you, your family, and your business, let’s talk.
1.“2024 Limitations Adjusted as Provided in Section 415(d),” IRS.
2. “How America Saves 2024,” Vanguard, 2024.
3. “Retirement topics: 401(k) and profit-sharing plan contribution limits,” IRS.
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