Why Safe Harbor 401(k) plans are the future of retirement planning

Employer contributions to retirement savings can be one of the missing links to making the retirement system more inclusive and financially impactful to millions of Americans if done right. Matching or additional funds from an employer provide incentives for both employers and employees. For the company, it means a tax break based on that contribution. For workers, it can mean extra savings.

Today, there is no law that requires employers to make a contribution to employees’ retirement savings, but future legislation could change that. Below, we’ll dig into what a Safe Harbor 401(k) plan is, and how the 401(k) of the future could mirror many of its features.

What is a Safe Harbor 401(k)?

A Safe Harbor plan is a special kind of 401(k) that automatically satisfies most nondiscrimination testing. It has certain built-in elements, such as a requirement for employer contributions, that are intended to help employees save more via their 401(k) accounts.

When employers offer this kind of plan, the IRS offers them “safe harbor” from certain nondiscrimination testing and the time-consuming consequences of failure. Employers also get a tax break on these contributions.

There are a few types of Safe Harbor 401(k) plans that have different requirements and both lead to the same results with regard to annual testing. For more specific details on differences within types of Safe Harbor plans, check out our Safe Harbor 2024 Guide for Employers.

Why Safe Harbor 401(k) are a glimpse of the future

There is increasingly talk in Washington about creating a national retirement mandate. That move could make all plans look a lot more like Safe Harbor 401(k) plans in the future. Here’s why:

If part of a new national mandate requires employer contributions, which is a possible scenario, the Safe Harbor 401(k) provides an existing framework that could be readily scaled to all companies and help them comply with the new mandate. (Even without a national mandate, there is also potential in future retirement legislation for new 401(k) plans to include automatic employer contributions.)

As part of the discussion for a future national mandate, some policymakers have pointed to Australia’s Superannuation Guarantee as a successful model. In Australia’s retirement system, employers are required to contribute at least 11% (and that’s going to 12% next year) to their workers’ retirement savings accounts.

Today, after several decades, the Superannuation Guarantee has fostered an incredibly robust retirement system for the country’s workforce.

In the U.S., Safe Harbor plan design could offer a way to scale employer contributions to workers’ 401(k) plans with existing plan infrastructure. However, differing from the Australian plan, the U.S. employer contribution rate would likely start much lower at 3 or 4% — similar to what’s offered in Safe Harbor plan design today.

And, as mentioned above, the built-in benefits of Safe Harbor plans for employers would be the ability to automatically satisfy non-discrimination tests and get tax breaks for their contributions; for workers the benefits would be additional savings.

In a Safe Harbor 401(k), U.S. workers can achieve a much higher savings rate compared with a traditional 401(k) that does not have a match). For example, using traditional Safe Harbor 401(k) with matching 4% of their compensation, an employee earning $50,000 with a $250 monthly contribution to their 401(k) — or $3,000 per year — would receive $2,000 in employer matching for a total of $5,000 saved in their 401(k) for the year. In this scenario, it could add up to a total annual savings rate to 10% versus 6%, which is the most common default employee savings rate.

With more widespread adoption of the Safe Harbor 401(k), Americans’ overall retirement savings rate could start to look a lot more like other countries such as Australia or the UK.

In the UK, pension reform over the last decade ushered in auto-enrollment, boosting participation; there is also a minimum employer contribution rate of 3%. Both aspects have helped shore up lagging savings for British workers. In countries like Sweden, Canada, and the Netherlands the minimum contribution rate is even higher, according to the Financial Times.

It’s still an open question whether a national retirement mandate will happen in the U.S. However, having a real-life model with Safe Harbor plans can help employers test-drive what kind of matching formula could work best for their company.