Touchstone Capital, Inc.
Theodore Kerr
President/CEO
2607 Nicholson Road
Building 2 Suite 1100
Sewickley, PA 15143
724-933-8388
tkerr@touchstonecapital.com
www.touchstonecapital.com
 
 




Traditional 401(k) plans are required to undergo testing each year to make sure the plans do not favor highly compensated employees (HCEs) and key employees over the rank-and-file non-HCEs. There are three primary tests: the actual deferral percentage (ADP) test, the actual contribution percentage (ACP) test, and the top-heavy test. The ACP and ADP tests are designed to compare plan utilization by HCEs and non-HCEs to ensure that usage is widespread and benefits all plan participants. The top-heavy test gauges the percentage of total plan assets that can be attributed to key employees.

The SECURE Act 2.0 signed in late 2022 ushered in two new tax credits for small employers adopting a retirement savings plan, one for plan startup costs and one for employer contributions. Now might be an ideal time to consider adopting a 401(k) plan for yourself and your employees to take advantage of these credits.

 

401(k) Plans for Small Businesses

Small business owners looking to adopt 401(k) plans are sometimes discouraged by the typically high costs and complicated testing requirements associated with plan administration (see sidebar). Fortunately, over the past few decades, legislators have introduced a number of simplified alternatives to the traditional 401(k) to help encourage more business owners to adopt these potentially valuable retirement benefit programs. Among them are the safe harbor plan, the qualified automatic contribution arrangement (QACA), and most recently, the starter 401(k) plan.

Safe Harbor Plan

In a traditional 401(k) plan, you're not required to make employer contributions. Safe harbor plans allow you to avoid testing by making fully vested contributions on behalf of employees.

You have several options. First, you can make a nonelective contribution of 3% (or more) of pay for each eligible employee, even those who aren't actively contributing. Alternatively, you can match employee contributions dollar for dollar up to 3% of pay and match contributions from 3% to 5% of pay at a 50% rate (the "basic match"). You also have the option of making an "enhanced" matching contribution that is at least as generous as the basic match.

Election change

With a safe harbor plan, you can decide as late as 30 days prior to the end of a plan year whether you'll use the 3% nonelective safe harbor for that year, which could be useful if you want to see how your testing is progressing before you commit to a safe harbor contribution for the year. Alternatively, your plan may be amended as late as the end of the year following the plan year, but only if the nonelective safe harbor contribution is 4%.

Employee contributions

As with traditional 401(k) plans, employees in safe harbor 401(k) plans can contribute up to $23,500 in 2025, plus an additional $7,500 for those age 50 and older ($23,000 and $7,500, respectively, for 2024).

QACAs

A QACA is a safe harbor 401(k) plan with an automatic enrollment feature. While most of the rules applicable to safe harbor plans also apply to QACAs, there are some notable exceptions.

Under a QACA, an employee who fails to make an affirmative deferral election is automatically enrolled in the plan. An employee's automatic contribution must be at least 3% for the first two calendar years of participation and then increase 1% each year until it reaches 6%. You can require an automatic contribution of as much as 15%.

Employees can change their contribution rate or stop contributing at any time and get a refund of their automatic contributions if they opt out within 90 days.

Your required employer contribution is either 3% of pay to each eligible employee or a dollar-for-dollar matching contribution up to 1% of pay and 50% on additional contributions of up to 6% of pay. You may also impose a two-year vesting schedule (compared to immediate vesting in a safe harbor plan). And if you select certain default investments for employee contributions, you'll generally be relieved of fiduciary responsibility for any losses your employees incur from those investments.

Starter 401(k) Plans

Employers with no other retirement plan (with limited exceptions) can adopt what's known as a starter 401(k) plan. Designed to be low cost and easy to administer, starter 401(k) plans allow only employee contributions. Employees must be auto-enrolled at a minimum contribution rate of 3% (not to exceed 15%) and may contribute up to $6,000 in 2025 ($7,000 for employees age 50 or older).

 Safe Harbor 401(k)QACAStarter 401(k)
Which employers can adopt?All nongovernmental employersAll nongovernmental employersAll nongovernmental employers that do not currently sponsor a plan
Employee elective contribution limit (2025)Lesser of $23,500 or 100% of compensation; additional $7,500 catch-up if age 50 or olderLesser of $23,500 or 100% of compensation; additional $7,500 catch-up if age 50 or olderLesser of $6,000 or 100% of compensation; additional $1,000 catch-up if age 50 or older
Required employer contribution (compensation limited to $345,000 in 2024)

·Dollar-for-dollar match up to 3% of compensation, 50% match above 3% to 5% (enhanced match also available) OR

At least 3% of compensation to each eligible employee

·100% vested

·Dollar-for-dollar match up to 1% of compensation, 50% match above 1% to 6% (enhanced match also available) OR

At least 3% of compensation to each eligible employee

·100% vested after 2 years

Employer contributions not permitted
Discrimination testingExempt from ADP test; exempt from ACP test if you make the safe harbor required contribution, don't match contributions over 6% of pay, and limit discretionary match to 4% of pay Exempt from ADP test; exempt from ACP test if you make the safe harbor required contribution, don't match contributions over 6% of pay, and limit discretionary match to 4% of payExempt
Top-heavy testingExempt if employer contribution limited to safe harbor required contribution; otherwise requiredExempt if employer contribution limited to safe harbor required contribution; otherwise requiredExempt
Additional employer contributions permitted?Yes (discrimination testing may be required); generally 3-year cliff or 6-year graded vestingYes (discrimination testing may be required); generally 3-year cliff or 6-year graded vestingEmployer contributions not permitted


The accompanying pages have been developed by an independent third party. Touchstone Capital, Inc. is not responsible for their content and does not guarantee their accuracy or completeness, and they should not be relied upon as such. These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your financial adviser. Touchstone Capital, Inc. does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. Investment advisory services offered through Touchstone Capital, Inc., a registered investment adviser.  Insurance products and services are offered and sold through individually licensed and appointed agents in all appropriate jurisdictions.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2025.