Traditional Safe Harbor 401(k) Plan vs. QACA – How to Choose

August 7, 2023

Plan Design

Safe harbor 401(k) plans are the most popular type of 401(k) used by small businesses today. Unlike a traditional 401(k) plan, they automatically pass the ADP/ACP and top heavy nondiscrimination tests when certain contribution and participant disclosure requirements are met. This trade-off is well worth the cost for many business owners, who often bear the brunt of the consequences when their 401(k) plan fails testing.

There are two basic types of safe harbor 401(k) plans available today – traditional and Qualified Automatic Contribution Arrangements (QACAs). Business owners should understand their differences because they can dramatically affect the cost and complexity of their 401(k) plan. In general, QACAs are more complicated to administer due to their automatic enrollment feature, but they can cost less due to more liberal contribution and vesting requirements.

Below is a summary of traditional and QACA safe harbor 401(k) plan requirements. If you’re a business owner, you can use this information to help choose the best option for your company.

Requirement	Traditional Safe Harbor Plan	QACA Safe Harbor Plan
Eligibility	Plan eligibility requirements cannot exceed statutory limits: Salary deferrals and safe harbor contributions – age 21 and 1 year of service Additional employer contributions – age 21 and 2 years of service To be credited with a year of service, an employee can’t be obligated to work more than 1,000 hours of service. Once an employee meets the age and service requirements, they can participate on the next plan entry date. Common entry date frequencies are monthly, quarterly, and semi-annually. To automatically pass the top-heavy test, eligibility requirements for the safe harbor contribution must match the salary deferral requirements.	Same.
Automatic enrollment	Not required.	Required. The default deferral rate must start at no less than 3% and increase at least 1% annually to no less than 6% (10% maximum). Annual escalator can be avoided by choosing a flat 6-10% default rate.
Contributions	Employers must make one of the following safe harbor contributions to participants: Basic match – 100% of salary deferrals up to 3% of compensation, plus 50% on the next 2% (4% of compensation total). Enhanced match – Must be at least as much as the basic match at each tier of the match formula. 100% match on the first 4% of compensation is common. Nonelective contribution – 3% (or more) of compensation, regardless of salary deferrals. HCEs can be excluded from safe harbor contributions. Allocation conditions can’t apply. Additional matching and profit sharing contributions permitted. The additional match can be exempt from the ACP test when certain conditions are met.	Employers must make one of the following safe harbor contributions to participants: Basic match – 100% of salary deferrals up to 1% of compensation, 1, plus 50% on the next 5% of compensation (3.5% of compensation total). Enhanced match – Must be at least as much as the basic match at each tier of the match formula. Nonelective contribution – 3% (or more) of compensation, regardless of salary deferrals. HCEs can be excluded from safe harbor contributions, Allocation conditions can’t apply. Additional matching and profit sharing contributions permitted. The additional match can be exempt from the ACP test when certain conditions are met.
Qualified Default Investment Alternative (QDIA)	Optional.	Same.
Vesting	Safe harbor contributions are subject to 100% immediate vesting. A 3-year cliff or 6-year graded vesting schedule can be applied to additional employer contributions.	Safe harbor contributions may be subject to a 2-year cliff schedule. A 3-year cliff or 6-year graded vesting schedule can be applied to additional employer contributions.
ADP/ACP testing	Not required unless one of the following conditions applies: Salary deferrals are subject to shorter eligibility requirements than safe harbor contributions. A match that’s not exempt from the ACP test is made by the employer. Voluntary (after-tax) contributions are made by participants.	Same.
Top heavy testing	Not required unless one of the following conditions apply: Salary deferrals are subject to shorter eligibility requirements than safe harbor contributions. A profit-sharing contribution (including a forfeiture reallocation) is made by the employer. A match that’s not exempt from the ACP test is made by the employer. Voluntary (after-tax) contributions are made by participants.	Same.
Participant disclosure	Match-based plans must distribute a safe harbor notice to participants prior to initial plan eligibility and then 30-90 days before the start of each new plan year.	Safe harbor notice must include certain automatic enrollment information.

What’s the best option for your small business?

In a recent study of 3,975 small business 401(k) plans, we found only 4% of safe harbor plans were QACAs. Why so low? I don’t see a lot of safe harbor plans with an employee participation problem - probably due to their generous employer contributions. When a safe harbor plan has no participation problem, it can be tough to justify an automatic enrollment feature. It adds administration that can be expensive to fix if mistakes are made.

That said, if you’re interested in a QACA, there is a simple way to avoid automatic enrollment mistakes - insist upon an affirmative deferral election from all plan participants.

If you have additional questions about the best safe harbor 401(k) options for your company, ask your 401(k) provider. They should be able to help.