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  • Writer's pictureSamantha Diggs

What is the Difference Between a Traditional 401(k) and a Safe Harbor 401(k)?

Updated: Mar 11, 2022

When choosing a 401(k) retirement plan for your employees, you should understand the associated benefits and it's effects on the company. With so many retirement plans out there, it can be difficult to understand the pros and cons of each. And sometimes, the one you chose doesn't provide the full benefits you had hoped for. In this blog, we will be discussing the two most popular retirement plans: a Traditional 401(k) and a Safe Harbor 401(k).

Traditional 401(k)

Traditional 401(k) plans are a good choice for employee retirement plans because they're cost-effective, however, they do need to pass annual IRS nondiscrimination testing.

Pros of Traditional 401(k) Plans

o Employee Incentive

Traditional 401(k) plans are among the most sought-after benefits that prospective employees look for when considering career options. Offering a 401(k) plan allows for employees to begin saving for their future and offers significant tax advantages for both parties.

o Cost-Effective

With a 401(k), employers are not required to make matching contributions, which can save company costs.

o Tax-Deductions

Employer contributions made to employee retirement accounts are tax-deductible which improves the employer's taxable income.

o Flexible Contributions

Employers can choose how much they would like to match on an annual basis. Additionally, plan sponsors may decide to match contributions or make profit-sharing contributions on a discretionary basis. These choices provide flexibility for the employer.

o Allocation Requirements

Employers can write the plan to require that an employee works a specified number of hours (not to exceed 1000) and/or require that an employee is still employed on the last day of the plan year to receive an Employer Contribution.

o Vesting Requirement

Employers can write the plan to include a vesting schedule on the Employer Contributions only providing the Employee a specified percentage of their balance attributed to these contributions each year up to a maximum of 6 years before they are fully vested in all the Employer Contributions.

Cons of Traditional Plans

o Nondiscrimination testing

A 401(k) must undergo annual IRS ADP, ACP, and top-heavy nondiscrimination testing.

o Contribution Limits

Due to the associated tests, there are also limits in place for contributions. Highly compensated employees must be aware that they may not be able to maximize their contributions, as this could lead to failing the ADP test depending on the level of participation from the non-highly compensated employees. Staying alert with the IRS annual contribution limits for all employees is a great way to solve this problem.

o Administrative Responsibilities

With testing and contribution limits to be aware of, there are increased administrative responsibilities associated with a traditional 401(k). Plan sponsors need to be aware of their plan design, IRS rules, and other guidelines in order to stay compliant.

Safe Harbor 401(k) Plans

Safe Harbor 401(k) plans are similar to traditional 401(k) plans but require limited annual testing.


o Exempt from several of the required compliance test

Safe Harbor 401(k) plans automatically pass the ADP and ACP tests and are deemed to meet the Top-Heavy requirements.

o Employee Retention

Under Safe Harbor Plans, employers are required to make contributions which can be an attractive benefit to retaining and attracting talent to the organization. With matching contributions, employees may increase their participation as well.

o Tax-Deductions

Employer contributions made to employee retirement accounts are tax-deductible which improves the employer's taxable income.

o Maximum Contribution

Employees who choose to participate in the safe harbor 401(k) can maximize their contributions as long as it does not exceed the annual IRS limits.


o Employer Contributions

While employees enjoy the mandatory employer contributions, these come at a cost to the company. The employer must pay these contributions periodically through the year or as a lump sum at the end of the plan year.

o Allocation Requirements

The plan cannot have any hours of service or last day of employment requirements for employees to receive the safe harbor contribution. If an employee is eligible and they defer they automatically receive the safe harbor match and/or they will automatically receive the safe harbor non-elective once they are eligible for the plan.

o Vesting Requirement

Safe Harbor plans require immediate vesting. This means, that once a contribution is made, the participant is the sole owner of that money.

o Administrative Responsibilities

While this plan is exempt from several annual compliance tests, there are still administrative responsibilities. Among these is a Safe Harbor notice that must be delivered to all plan participants annually, at least 30 days before the plan year-end.

How to Choose: Traditional 401(k) vs. Safe Harbor 401(k)

When it comes to choosing a retirement plan for your business, the choice is yours. If you are concerned that your plan will not pass annual ADP/ACP testing then, a safe harbor 401(k) may be the better option. However, if you can pass these tests with ease and want to incentivize your employees with allocation conditions or vesting schedules, a Traditional 401(k) may be the right choice for you. When choosing between a Traditional 401(k) versus a Safe Harbor 401(k), be sure to consider your retirement plan goals, budget, and overall fit for your organization. If you would like assistance with choosing the right retirement plan for your organization, contact a member of the RPCSI team today - we are here to help.

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