Look Beyond the Traditional 401(k) Plan

Physician's Money Digest, October15 2003, Volume 10, Issue 19

During the past decade, 401(k) plans havebecome the country's most popular form ofretirement plans. Employers recognize thata 401(k) can help attract and retainemployees. However, administrative costs, nondiscriminationtests, and compliance tests have made itdifficult for small medical practices (ie, practices withless than 25 employees) to establish 401(k) plans.Fortunately, things are changing.

There is now a safe harbor option that allows anemployer to omit actual deferral percentage and relatedcompliance tests. The reasoning behind this safeharbor: If a plan provides certain minimum benefits toensure broad participation, the company should nothave to prove yearly that the plan is nondiscriminatory.This change has led to the formation of the SafeHarbor 401(k) plan.

Safe Harbor Overview

A Safe Harbor 401(k) plan is an attractive choicefor young physicians just starting a medical practiceand physician owners who are older than theiremployees, because it satisfies traditional retirementplans' antidiscrimination and top-heavy requirements.In addition, it allows highly compensated employees,whose previous contributions were limited, to takeadvantage of the salary deferral feature—somethingnondiscrimination requirements would have preventedthem from doing in the past.

All Safe Harbor 401(k) contributions are fully vestedand funded by pretax payroll investments for bothowners and employees. Moreover, with a Safe Harbor401(k) plan, owners are no longer dependent onemployee participation to achieve maximum pretaxpayroll deferral limits. Eligible employees who terminatetheir plan will receive an allocation, regardless ofwhen they leave during the plan year.

The plan allows employers to contribute up to25% of eligible compensation (capped at $200,000)per eligible employee. The employer can also elect tomatch contributions, which provide them with costsavings. Only employees who make a payroll investmentreceive the match. Highly compensated employeesmay also receive matching contributions as long astheir matched contributions don't exceed those providedto nonhighly compensated employees.

Contribution Options

A safe harbor design can only be used if participantsare notified of the rights and obligations under thearrangement before the design is implemented. Theemployer must notify participants prior to the start ofthe plan year which safe harbor contribution has beenchosen and whether any additional contributions can bemade. If an employer doesn't select the nonelective 3%pro rata contribution, they have the following options:

  • Basic match. This entails a 100% match on thefirst 3% deferred, and a 50% match on deferralsbetween 3% and 5%.
  • Enhanced match. This is a match at any rate thatat least equals the basic match (eg, 100% of the first 4%deferred) and doesn't increase as the deferral rateincreases. The match rate for highly compensatedemployees cannot exceed the rate for nonhighly compensatedemployees, unless limited by IRC 415 or402(g). The enhanced match may not be based on deferralsin excess of 6% of the participant's compensation.

Bottom line:

The Safe Harbor 401(k) plan provides many benefits.It reduces administrative costs and burdenswhile ensuring that the practice's retirement plan is incompliance with requirements. Employees receivemore employer dollars on their own behalf. And highlycompensated employees will appreciate that theirdeferral contributions are no longer tied to the deferralrates of nonhighly compensated employees. The Safe Harbor 401(k) plan offers ownersand highly compensated employees maximum tax-advantageleverage and assures equitable treatmentfor all employees.

William J. Connington III is a wealth advisor and owner ofConnington Wealth Management Group in Pine Brook, NJ. Hespecializes in working with health care professionals who are committedto long-term investing and improving the quality of theirlife. He welcomes questions or comments at 973-808-8181 orbill@conningtonwealth.com.