Safe Harbor 401 K

Annuities the Next Big Retirement Option?

Many baby boomers will be retiring on savings, without the secure pension checks that their parents enjoyed. As more boomers embark on this adventure, it is becoming increasingly clear that getting through retirement by living off investments is too difficult and unpredictable for most of us.

This uncomfortable conclusion is driving the government, employers and particularly insurers to come up with an alternative -- something that works a lot like an old-fashioned defined benefit pension plan.

So far, the likeliest candidate is an annuity within a 401(k) plan. Last September, the U.S. Department of Labor's Employee Benefits Security Administration and the Treasury Department sponsored a hearing on these lifetime income options. At the end of the sessions, it seemed clear that annuities within 401(k)s were a concept that employers, the government and -- especially insurance companies -- were happy to embrace.

Enthusiasm doesn't trickle down

There is just one big problem. Most employees are somewhere between stone cold and lukewarm to the idea. The Department of Labor asked for public responses to its proposal to approve annuities as "safe harbor" investments within retirement plans. The average response among the 800 received wasn't too far away from this one by Ross L. Webster, a retired Marine from North Carolina:

"Do you think Americans are IDIOTS? You would like to take our hard-earned money in IRAs and 401(k)s that WE CONTROL and promise a lifetime annuity that we can trust YOU to pay in the future?"

Despite public skepticism, some employers and retirement plan sponsors are already offering annuities or annuity-like products in 401(k)s. Prudential Financial says it has about 6,000 401(k) plans that have made its Income Flex plan an option for its employees. Phil Waldeck, a vice president who leads Prudential's pension plan risk management, says the key is to provide a plan that guarantees a minimum payout while providing participants with potential increases if the market is good and their savings grow.

New and improved annuities

"When you say annuity, people think single balance that converts into a fixed-income payout that is flat and irrevocable. People don't want that. What we're offering is a variable solution with a minimum withdrawal benefit with upside potential. That is starting to be embraced," Waldeck says.

Most participants in the Prudential plan, Waldeck says, choose to move their money into the accumulation phase of the Income Flex plan when they are around age 50, the youngest age at which they can secure a guaranteed minimum amount. That gives them time to increase contributions so they can lock in as high a payment as possible at retirement. Once they move their money to the plan, participants know the minimum that they will receive monthly no matter what happens to the market as they approach retirement.

What Is Safe Harbor 401K? | 401k Contribution Limit

Safe harbor 401K is a type of 401K retirement plan which permits the participation of employees, as well as employers in terms of funding for contributions. This type of 401K plan has more advantages compared to traditional 401K.

Some of the key features of Safe Harbor 401K:

With safe harbor 401K, employees can enjoy pre-tax salary deferrals just like the traditional 401K. The contribution limit is set at $16,500 and the catch-up contribution at $5,500 per year for employees who are over 50 years old.

Employees with higher salaries can make maximum salary deferral contributions without worrying about the ACP and ADP refunds due to low employee participation.

Safe harbor plans are less complicated since they are supposed to pass the ACP and ADP non-discriminating tests automatically as required by the traditional 401K.

Employers can either make a matching or a profit sharing contribution, or both. They are also required to make minimum contributions that are fully vested. And due to the flexibility of this plan (in terms of similar eligibility requirements, distribution options and loans), employers can offer it to employees and decide on the plan status on a per year basis.

Safe Harbor 401K may be offered by companies or businesses that wish to establish employer-sponsored retirement plan for their employees. Companies that are thinking of maximizing their contributions are good candidates for this type of retirement plan since it is not subject to the ACP and ADP tests. Companies that are willing to fund the required contributions on their employee’s behalf are also among those who are qualified.

Companies may adopt a safe harbor 401K plan if they are able to satisfy top heavy requirements since the plan itself can satisfy such requirements automatically. Similarly, companies that can offer stronger benefits and guaranteed contributions via safe harbor, may use it as an attractive benefit for recruiting and retaining employees.

Probably one of the most important advantages of safe harbor 401K is its ability to help both employees and employers get higher tax savings. Employers contributing to this plan can get tax deductions since the salary deferrals are usually made prior to withholding the federal income tax. The growth of the contributions is tax-deferred in this case.

There are many more features and benefits that employers and employees can get from safe harbor 401K plans. If you wish to know more, it is best to check the IRS website and other finance-based publications online or offline. You may also consult with a financial adviser if you have one.

401(k)s For Dummies

401(k) answer book

The Employers' Handbook to 401(k) Savings Plans

Code of Federal Regulations, Title 26, Internal Revenue, Pt. 1 (Sections 1.401-1.440), Revised as of April 1, 2009

Income Tax Regulations, Winter 2009 Edition (Six Volume Set)