One of the problems faced by employers sponsoring a 401(k) profit sharing plan is the required non-discrimination testing. This testing compares the elective deferrals made by non-highly compensated employees (NHCEs) to the elective deferrals made by highly compensated employees (HCEs). If the NHCEs have a low participation rate, it can greatly affect the ability for HCEs to participate (i.e. HCEs will be limited as to how much they can defer to the plan).
One way to avoid problems with the non-discrimination testing is to set the plan up as a safe harbor 401(k) plan. A safe harbor 401(k) plan is deemed as satisfying the ADP test. In other words, all HCE's can defer up to the dollar limit ($15,500 in 2008), regardless of how much NHCEs defer.
To qualify for the ADP safe harbor, the plan must satisfy the following conditions:
To satisfy the ADP safe harbor contribution requirement, the employer must make either a safe harbor matching contribution or a safe harbor non-elective contribution. This safe harbor contribution must apply to at least all the NHCE's, and must be 100% vested.
A popular new plan type is to combine the allocation formula of a new comparability 401(k) profit sharing plan with the testing requirements of safe harbor 401(k) profit sharing plan. This type of plan can work very well for an employer who wants to maximize contributions to a select group of employees, but has a low NHCE participation rate.
Another popular plan type is a safe harbor 401(k) plan that uses a matching contribution to satisfy the safe harbor requirements, and has no additional employer discretionary contribution. Because employer contributions to the plan consist only of safe harbor contributions, the plan is deemed not top heavy. All employees are able to defer up to the limit, and the employer only has to make matching contributions on up to 4% of compensation. If a participant does not defer, the employer is not required to make a contribution for that participant.