Current Thinking

Cross Tested Plans

A Cross Tested plan is a type of 401(k), Money Purchase Pension Plan, or Profit Sharing plan that can be designed to slant employer contributions in favor of older, higher paid employees. New Comparability plans and Age Weighted plans are both types of Cross Tested plans.

Cross Tested plans use non-traditional allocation methods. Under a Cross Tested plan, an organization can place participants in their own groups, or segments. These groups are typically determined based on length of service or compensation, or attaining certain organizational goals. On an annual basis, the organization determines much it will contribute on behalf of each individual or group of individuals.

HOW DO NON-DISCRIMINATION RULES APPLY TO CROSS TESTED
PLANS?

A qualified retirement plan may not discriminate in favor of Highly Compensated Employees (“HCE’s”). Under a traditional plan design, contributions are tested each year to determine whether a plan satisfies these requirements. Under a CrossTested plan, testing is performed based on benefits received rather than dollars
contributed.

WHAT MAKES CROSS TESTED PLANS UNIQUE?

Cross Tested plans are unique in that they are tested in terms of projected retirement benefits provided rather than on contributions allocated to a participant’s account.

This is permissible 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), for demonstrating that the benefits provided to highly compensated and non-highly compensated employees are comparable.

IS THERE ANY ADVANTAGE TO OFFERING A CROSS TESTED PLAN?

Cross Tested plans offer the ability to create multiple benefit levels within a retirement plan to meet the overall needs of an organization.

WHAT TYPES OF BUSINESSES BENEFIT FROM A CROSS TESTED PLAN?

Generally smaller employers with stable workforces are good candidates for a Cross Tested plan. These types of plans are typically well-suited for small businesses and professional practices.

CAN A CROSS TESTED PROVISION BE ADDED TO A CURRENT 401(K)
PLAN?

Yes, if a 401(k) plan has a profit sharing feature, the profit sharing formula can be changed to a Cross Tested formula.

ARE CONTRIBUTIONS TO CROSS TESTED PLANS TAX DEDUCTIBLE?

Employer contributions to cross tested plans are generally tax deductible up to 15% of eligible payroll.

ARE CONTRIBUTIONS DISCRETIONARY?

Yes, contributions to Cross Tested plans are completely discretionary, which gives an employer the flexibility to increase, decrease, stop contributions, however the time frame for making these changes depend upon the plans rules.

WHAT ARE THE DIFFERENT TYPES OF PLAN DESIGNS FOR CROSS TESTED
PLANS?

Typical Cross Tested plan designs include New Comparability Plans and Age-Weighted plans. With both types of plans, if non-discrimination requirements are met, a larger share of the employer’s contribution may be made on behalf of those employees to whom the employer wishes to provide more significant benefits.

HOW DOES A NEW COMPARABILITY PLAN DESIGN WORK?

Under a New Comparability Plan design, employees are divided into groups or classes that can be based on age, length of service and/or level of compensation. Each group receives a different level of contributions. While the classes of employees must be defined in the plan document, the actual contribution percentage can be
decided at the end of each plan year.

The plan generally provides higher contributions to older, higher-paid, presumably “key” employees, while younger, and/or lower paid employees receive a lower percentage of the total employer contribution to the plan. New Comparability plans are typically designed to benefit owners and key employees over rank and file employees, and can be used if the employer wishes to give different contribution percentages to different classifications of employees. New Comparability plans skew benefits toward a selected group of participants, but provide greater control than Age-Weighted plans.

Below is a simple example of how a New Comparability plan might construct groups:

Group 1   Owner
Group 2   Middle Management
Group 3   All other employees

HOW DOES AN AGE-WEIGHTED PLAN DESIGN WORK?

Under an Age-Weighted plan design, employer contributions are allocated among eligible employees based on both age and salary. Since a participant’s time horizon to retirement is factored into the allocation, older, more highly compensated employees tend to receive a larger share of the contribution. While Age-Weighted
plans tend to skew benefits toward older participants, control of exactly who benefits the most is limited.

An Age-Weighted profit sharing plan can have a discretionary contribution formula and provide the employer with flexibility over the amount of the contribution to be made each year. Age-Weighted Plans, similar to traditional profit sharing plans, limit the employer’s maximum deductible contribution to 25% of the participant’s compensation. The maximum annual contribution of any plan participant is equal to the lessor of 100% of compensation, or $51,000 for 2013. There are no minimum required annual contributions.