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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 lesser amounts.
  • 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 'eligible' payroll.
  • 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 accounts currently.
  • 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.

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Information is provided for review and consideration only. Please consult legal and tax advisors for practical advice pertaining to your business and personal situations.

This page was last reviewed and/or updated on Monday, October 21, 2013 09:58 AM

 

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