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A Handy Guide to Safe Harbor 401(k)s and Their Nondiscrimination Tests

Nicolle Willson Certified 401(k) Professional, Certified Financial Planner (CFP®) 
safe harbor 401k non-discrimination

While a Safe Harbor 401(k)s has an unusual name and specific requirements, they are incredibly popular with small business owners. In a nutshell, Safe Harbor plans generally require less administrative work, they can strengthen an already popular benefit, and they can provide employers with peace of mind since there is typically less to worry about when it comes to IRS nondiscrimination tests. Below, we outline what nondiscrimination tests are and how you can best prepare for them.

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What’s a Safe Harbor 401(k) and how does it differ from a traditional 401(k)?

The IRS requires annual nondiscrimination tests that are intended to help ensure that a 401(k) benefits all eligible employees, not just highly compensated employees. A Safe Harbor 401(k) is a special type of 401(k) plan that is exempt from most of the annual IRS nondiscrimination tests that apply to traditional 401(k) plans. In exchange, companies must contribute to their employees’ 401(k) accounts using a specific formula. 

Why should my clients consider opening a Safe Harbor 401(k)?

In addition to worrying less about nondiscrimination testing, Safe Harbor plans also offer a big benefit to employers and employees. Specifically, employers and other highly compensated employees can more easily max out their own 401(k) elective deferrals. Additionally, your clients’ employees can get a savings boost, since Safe Harbor plans require an employer contribution. 

Tell me more about these nondiscrimination tests. Why do they matter?

Nondiscrimination tests are required by the IRS to help ensure that the 401(k) plan benefits everyone, not just highly compensated employees or key employees (like owners). Generally, these nondiscrimination tests must be completed each year. Here’s a quick overview of the three main tests.

The Actual Deferral Percentage (ADP) test


According to the IRS, this test “compares the average salary deferrals of highly compensated employees (HCEs) to that of non-highly compensated employees (NHCEs). Each employee’s deferral percentage is the percentage of compensation that has been deferred to the 401(k) plan.” 

The ADP test is calculated by dividing the amount an employee defers by their total W-2 income.

Basically, this test measures how much income HCEs and NHCEs each contribute to their 401(k). 

Here’s a quick illustration:

EmployeeDeferral percentage
Johnny R. (HCE)10%
Moira R. (NCHE)0%
Alexis R. (NCHE)5%
David R. (NCHE)4%

Johnny’s deferral is obvious: 10%. The rest of the NHCEs have an average deferral of 3%.

The Actual Contribution Percentage (ACP) test

The ACP test is similar to the ADP test, but it compares the average matching contributions received by HCEs and NHCEs, rather than how much they defer. ACP is calculated by dividing the company’s matching contribution to an employee’s account by their compensation.

EmployeeW-2 incomeCompany contribution (50% of first 6% deferred)Contribution percentage (Contribution / W-2 income)
Johnny R. (HCE)$150,000$4,5003%
Moira R (NCHE)$30,000$00%
Alexis R (NHCE)$30,000$7502.5%
David R. (NHCE)$30,000$6002%

As before, Johnny’s contribution is obvious: 3%. The average of the NHCE is 1.5%.

Passing the ADP and ACP tests

To pass the ADP and ACP test, HCE deferral rates must fall below the following:

  • If the ADP or ACP for NHCEs is 0%-2%, the rates for HCEs must not be more than two times the NHCE rate.
  • If the ADP or ACP for NHCEs is 2%-8%, the ADP for HCEs must not exceed the NHCE rate by more than 2%.
  • If the ADP or ACP for NHCEs is greater than 8%, the ADP for HCEs must not be more than 1.25 times the NHCE rate.

Continuing with the example above, the NHCEs had an average ADP of 3%. That means the ADP of HCEs can’t be more than 5% (the 3% NHCEs deferred, plus 2%). Since the HCE defers 10%, this plan fails the ADP test.

For the ACP test, the NHCEs received an average contribution that was 1.5% of their W-2 income. To pass the test, HCEs can’t receive more than double the NHCE average — a maximum of 3% in this case. It turns out that the HCE receives 3%, so this plan passes the ACP test by the narrowest of margins.

Top-heavy test

This third test focuses on “key employees,” such as owners of an organization, as opposed to HCEs. It tests the plan’s balance as of December 31 of the previous year (or current year, if it is the plan’s first year). The plan fails this test when the value of the assets in key employees’ accounts is more than 60% of all assets held in an employer’s 401(k) plan.

“Key employees” is defined by the IRS as:

  • An officer making over $185,000 in the plan year for 2021, OR
  • Anyone who owns more than 5% of the business (including certain family members via attribution rules), OR
  • An employee owning more than 1% of the business (including certain family members via attribution rules) and making over $150,000 for the plan year.

The top-heavy test also differs because it tests the plan’s balance as of December 31 of the previous year (or current year, if it is the plan’s first year). A plan fails the top-heavy test when the value of the assets in key employees’ accounts is more than 60% of all assets held in an employer’s 401(k) plan.

Passing the top-heavy test

Returning to our example one more time, we’ll assume that the plan’s assets have grown 10% and that Johnny is the only key employee. Here’s how the numbers shake out:

EmployeeW-2 incomeW-2 income deferred + company contributionTotal assets in plan (assumes 10% growth)
Johnny R (key employee)$150,000$19,500$21,450
Moira R.$30,000$0$0
Alexis R.$30,000$2,250$2,475
David R.$30,000$1,800$1,980

In this scenario, the total plan assets are $25,905. Johnny— the only key employee— has about 83% of the plan assets, which is more than 60%; therefore, the plan fails the top-heavy test.

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How does an employer match/contribution work?

A company’s contributions to its employees’ 401(k) plans have a big impact on whether the company will pass the three nondiscrimination tests listed above. Accordingly, here are the two types of employer contributions:

  1. Matching contributions, which are based on how much employees choose to defer.
  2. Nonelective contributions, which are made whether or not an employee defers income to his or her 401(k).


This is where the Safe Harbor 401(k) comes in. A Safe Harbor 401(k) is exempt from most nondiscrimination tests. But in order to qualify for the safe harbor treatment, you must contribute to your employees’ 401(k).

What deadlines should I be aware of?

 The deadline to start a Safe Harbor 401(k) for 2021 has already passed, but don’t fret. You can still start a Guideline Safe Harbor 401(k) for 2022 if you sign up by November 19, 2021. Guideline is also waiving employer fees for your 1st month until December 31, 2021.2 Learn more.

Some benefits of starting a 401(k) in the beginning of the year include more time for employees to maximize their contributions, easier onboarding and administration, and perhaps most importantly, mitigating compliance risks. You can read more about the benefits of starting a 401(k) on Jan 1, 2022 here.

A special offer for your clients

Guideline’s monthly plans start at $49 + $8 per active participant.1 If you think that Guideline might be a good fit for your clients, help them open a new 401(k) plan or convert an existing plan by December 31, 2021 and Guideline will waive the employer fees for the first month.2 

Learn more here.

1 Learn more about Guideline’s services and fees here.

2 Customers who sign up with Guideline by December 31, 2021 pay no monthly base fee and no $8 monthly participant fee for 1 month after the new plan begins. This offer cannot be combined with other offers.

Nicolle Willson
Nicolle Willson Nicolle Willson is a Certified 401(k) Professional and Certified Financial Planner (CFP®) at Guideline 401(k). She also holds a J.D. from UCLA School of Law.

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