Avoid the ADP Test with a Safe Harbor 401(k) Plan

By David J. Kupstas, FSA, EA, MSEA

David J. Kupstas, FSA, EA, MSEA

David J. Kupstas, FSA, EA, MSEA Chief Actuary

The ADP test for 401(k) plans is like a mosquito:  it is annoying and has no known benefit to society.  The worst outcome of a failed ADP test is you have to refund excess contributions to Highly Compensated Employees.  At a minimum, you’ve wasted time performing the test that could have been spent with your family or enjoying a good book.

Before 1999, just about every 401(k) plan had to perform the ADP test every year.  Then, Congress came up with something called the safe harbor 401(k) which allowed plans to bypass ADP testing.  In exchange for the privilege of avoiding the ADP test, companies would have to contribute at least a minimal amount to plan participants and meet certain other requirements. 

Two Flavors of Safe Harbor Contribution 

There are two types of safe harbor contributions:  a nonelective contribution and a matching contribution.  Both types of contributions must always be 100 percent vested.  There cannot be a requirement that a participant complete a year of service or be employed on the last day of the year to receive the contribution. 

  • The safe harbor nonelective contribution must be at least 3.00 percent of the employee’s compensation. The employee does not have to make a salary deferral contribution to receive the nonelective contribution.
  • The basic safe harbor matching contribution is equal to the sum of
    • 100 percent of the employee’s deferrals that do not exceed 3.00 percent of compensation, plus
    • 50 percent of the employee’s deferrals that exceed 3.00 percent of compensation but do not exceed 5.00 percent of compensation. 

An enhanced matching contribution may be made instead of a basic match.  An enhanced match is a match that is greater than or equal to the basic match at every level of salary deferral.  A dollar-for-dollar match on salary deferrals up to 4.00 percent of pay is an example of an enhanced match.  

The following table illustrates the basic matching contribution and enhanced matching contribution at various levels of deferral: 

Deferral %

Basic Match %

Enhanced Match %
















5.00% and higher



Basic match = 100% of deferrals up to 3.00% of pay and 50% of deferrals between 3.00% and 5.00% of pay.

Enhanced match = 100% of deferrals up to 4.00% of pay.

If an employer is looking to make the lowest contribution possible while satisfying the safe harbor, which type of safe harbor contribution is better?  The nonelective contribution is 3.00 percent of pay.  The basic matching contribution could be as high as 4.00 percent of pay.  On that basis, the nonelective contribution looks like it could be the better deal, since 3.00 percent is less than 4.00 percent. 

On the other hand, what if every employee makes a salary deferral of exactly 2.00 percent of pay?  In that case, the matching contribution would be only 2.00 percent of pay, making it less expensive than the 3.00 percent nonelective contribution.  Which safe harbor contribution type is cheaper for the employer depends in part on how much the employees defer. 

We almost always recommend a nonelective safe harbor instead of the match, particularly in cross-tested plans, because nonelective contributions are treated more favorably in nondiscrimination testing.  If the plan uses uniform allocation or integrated profit sharing, or if there is no profit sharing contribution at all, we are more likely to recommend the safe harbor match. 

Other Safe Harbor Contribution Notes 

    • If a plan is safe harbor and the match or nonelective contribution is the only employer contribution made, a plan that is top-heavy is exempt from the top-heavy minimum contribution requirement.
    • In addition to the ADP test, an employer can use safe harbor contributions to avoid the ACP test as well, provided these four criteria are met: 
      • Matching contributions under the plan may not be based on deferrals that exceed 6.00 percent of pay.
      • The maximum discretionary match may not exceed 4.00 percent of pay. Any match given in addition to this must be a fixed match spelled out in the plan document. 
      • Matching contributions as a percent of deferrals may not be higher for HCEs than Non-Highly Compensated Employees.
      • The rate of matching contributions may not increase as deferrals increase.
    • There are safe harbor rules for Qualified Automatic Contribution Arrangements (QACAs) which are beyond the scope of this article.  

Notice Requirement 

Besides the contribution requirement, there is a notice requirement for safe harbor 401(k) plans which includes a content requirement and a timing requirement. 

        • Content requirement: The notice must be accurate, comprehensive, and understandable to the average employee.  The notice should explain what safe harbor contribution is being given, what other contributions are available under the plan, how to make cash or deferred elections, and more. 
        • Timing requirement: The notice must be given out within a reasonable period before the plan year starts.  Between 30 and 90 days before the plan year begins is deemed to be a reasonable period.  While the regulation does not say that 30 days before the plan year starts is an absolute deadline, most people have interpreted it as such, and we believe it is wise to try and meet that timeframe.  Sometimes, it is not possible to meet this timeframe; perhaps the plan is established after the 30- to 90-day window ends or an employee doesn’t become eligible until after the plan year starts.  In these cases, extra time is allowed.

Since the safe harbor notice has to be issued before the plan year begins, this generally means the employer cannot just decide late in the year or after the year ends that it wants to have a safe harbor plan.  The employer must commit in advance to giving a safe harbor contribution for the upcoming year.  That said, there are a few exceptions to this general rule:

          • Safe harbor contributions may generally be reduced or suspended if a 30-day notice is given. Full safe harbor contributions would have to be given on deferrals made or compensation paid prior to the reduction or suspension, as applicable.  The plan would need to satisfy the ADP test for the full year.
          • Instead of committing to a nonelective contribution before the year starts, an employer can issue a “maybe” notice. This says the employer might give a 3.00 percent nonelective contribution.  Right around the time the usual safe harbor notice is given out for the upcoming year (Novemberish) is when the employer has to announce once and for all whether it is doing the safe harbor for the current year.  If the employer utilizing the maybe notice opts not to have the safe harbor for the year, the plan must satisfy the ADP test for the full year. 

Rules Have Been Eased.  Is There More to Come? 

The rules on safe harbor plans were quite strict when they first came out.  Gradually over the years, some of the strictness has been peeled away.  For example, the concept of the maybe notice did not exist right away.  You also initially weren’t able to discontinue mid-year the nonelective contribution committed to prior to the start of the year.  If you chose to do a 3.00 percent nonelective contribution, you were locked into it for the whole year unless the plan were terminated in its entirety.

There really wasn’t much flexibility in being able to amend safe harbor plans mid-year at all.  It was interpreted that virtually any change to a safe harbor 401(k) – even one that seemingly had no effect on the safe harbor rules themselves – was prohibited until the beginning of a plan year when it could be reflected in the annual notice to participants.

Fortunately, the IRS clarified in Notice 2016-16 that most mid-year changes to safe harbor plans are indeed allowed, so long as you give proper notification to employees and allow them to change their deferral elections.  A limited number of prohibited mid-year changes remains.

Then there was the question of whether forfeitures could be used to fund safe harbor contributions.  Forfeitures occur when an employee who is not fully vested is paid out from the plan and forfeits the unvested portion of his account.  Forfeitures may be used in a number of ways, including reducing future contributions.  Until early 2017, the rule was you couldn’t use forfeitures to pay for safe harbor contributions because safe harbor contributions had to be fully vested when made.  There was no way a forfeiture could have been fully vested “when made” because a fully vested contribution by definition cannot become a forfeiture.  Hmmm.  A proposed regulation now says that safe harbor contributions must be fully vested “when allocated to participants’ accounts,” opening the door for forfeitures to be applied toward safe harbor contributions, assuming your plan document allows it.

The most recent development may be the most exciting of all.  Under a Senate bill called the “Retirement Enhancement and Savings Act of 2018,”  the following changes would be made: 

          • You would be allowed to amend a plan to provide the nonelective safe harbor all the way up until 30 days before the plan year ends. The nonelective contribution required would remain 3.00 percent of pay.
          • If that wasn’t enough time, you could amend a plan to provide the nonelective safe harbor even after the plan year ended (up to 12 months after). The only hitch?  The nonelective contribution would have to be 4.00 percent of pay rather than 3.00 percent.  Still, it beats running the ADP test.
          • The above proposed changes apply only to nonelective contributions. A matching safe harbor would still need to be adopted before the plan year begins.
          • There would be no more notice requirement for nonelective safe harbors. Only the matching safe harbor would require a notice.  This change makes sense.  Why are you required to give such early notice about a 3.00 percent-of-pay contribution that a plan participant gets automatically without having to do a thing?  If someone gives me 3.00 percent-of-pay, I am fine with not finding out about it until later.  (The rule is probably there so employees can adjust their deferrals downward upon hearing that the employer is kicking in 3.00 percent.  In our opinion, that is not sufficient justification for the aggravation that comes from having to give out a notice.)

If the RESA provisions make it into law, we will have a separate post on this topic – but not until after we’ve had a party at our office celebrating the removal of these burdensome rules.  Stay tuned.   

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— Topics: 401(k), defined contribution