The 'Cross-Tested' Approach
A new comparability or 'cross-tested' plan is an
employer-sponsored, defined contribution retirement plan, or a
combination defined contribution plan and a cash balance plan, which
favors older, long-term employees, who by age are closer to retirement.
The plan design permits an employer to contribute to retirement
investment accounts and/or in the case of cash balance plans,
hypothetical accounts earmarked or allocated for each participant.
Unlike traditional profit sharing plans, which may provide a flat dollar
amount or a flat percentage formula of 10% for each participant, the
participant's age, service and compensation are taken into account when
determining the allocation of these contributions.
Under a new comparability plan design, the percentage
of the plan contributions going to the investment accounts of owners and
other highly compensated employees can be much higher than under a
traditional profit sharing plan - if they are older on average
than the other employees, and have longer records of service. This is
permitted because IRS regulations provide a method, based on an analysis
of projected benefits at retirement age (rather than the amount of the
contribution currently allocated to a participant), of showing that the
benefits provided to highly compensated and non-highly compensated
employees are comparable.
- This strategy permits older, long-term employees
to receive the annual maximum contribution for a qualified
retirement plan, which is the lesser of 25% of compensation or
$50,000 (indexed for 2012) or substantially more when combined with
a cash balance plan, while younger and/or newer employees receive
- Employer costs may be lower in a new comparability plan design
when compared to other types of qualified pension plan funding
strategies - particularly defined benefit plans.
- Employer contributions are generally tax deductible up to 25%
(and even more if combined with a cash balance plan) of total
- For participants, the benefit is that the employer's
contributions are not included in the participant’s current taxable
income. In addition, interest accumulates on a tax-deferred basis.
Taxes are payable upon distribution - presumably at retirement, when
lower overall tax rates may apply due to reduced income.
- Since an employer is allowed to vary the allocation of plan
contributions among participants according to their age, service and
compensation, older, long-term, more highly paid participants
receive a greater portion of the total contribution. This is
accomplished by testing for nondiscrimination based on comparing the
benefit employees will receive when they reach retirement age
(called “cross-testing”) - rather than how much is put into their
- Within plan guidelines, employers decide how much to contribute
every year. Contributions may be increased or decreased at any time
and may be stopped if desired. Contributions also may generally be
rolled over into another retirement plan by participants at
termination of employment.
- This design strategy provides for up to 25% of total eligible
payroll (and even more if combined with a cash balance plan) as a
tax-deductible contribution. The maximum annual amount allocated for
any one participant cannot exceed the lesser of 25% of a
participant’s compensation from the employer or $50,000 (indexed for
2012) or even more when combined with a cash balance plan. Other
limitations may apply in a dual plan situation, also referred to as
combination or ‘combo’ plan design.
- Since contributions are discretionary for the defined
contribution plan, an employer can stop, resume, increase or
decrease the contributions. Actual time limitations for making such
changes depend upon the plan's rules found in the plan document. If
the new comparability plan cannot satisfy non-discrimination tests
for any given year, the plan is automatically switched to the next
best allocation formula available.
At Executive Benefit Plans we've specialized in designing retirement
and pension plans for more than thirty years and new comparability, dual
or combo plans for clients for over fifteen years. If this is strategy
is of interest to you and may benefit your organization, please contact
us to discuss your particular situation in more detail.