United States

What is a new comparability plan?

INSIGHT ARTICLE  | 

A new comparability plan is a type of qualified defined contribution profit-sharing plan that allows a business to maximize the plan contributions to older, higher-paid owners and key employees while minimizing allocations to the accounts of younger non-highly paid employees.  A new comparability plan is the new generation of an age-weighted plan and is common among smaller businesses.

“A company that already has a traditional 401(k) can overlay cross testing on top of that,” explains Jay Well, a financial adviser with Foresight Wealth Management in Sandy, Utah. “It changes the way the 401(k) is tested for non-discrimination. In typical non-discrimination testing, the Internal Revenue Service (IRS) looks at how much money is being contributed and whether highly compensated employees (HCEs) and non-highly compensated employees (NHCEs) are benefitting equally. Cross-testing looks at the benefit of those contributions at retirement. Because younger employees have a longer time horizon to grow their assets, it permits employers to contribute more for their older employees.1

Plan participants are divided into two or more classes or groups (rather than strictly using age), and each class or group may have a different contribution formula.  Each person can often be assigned his or her own contribution percentage.

Business owners or highly compensated employees may be able to benefit from a higher percentage of the plan contribution than allowed for under a traditional profit-sharing plan or even an age-weighted plan.  Or, they may be able to receive the same dollar amount of contribution as under a traditional profit sharing plan but reduce the overall contribution amount for other employees.

Examples of groups:

  • Highly compensated employees / nonhighly compensated employees
  • Administrative staff / office managers
  • Owners / officers
  • Employees over or under a specific age
  • Los Angeles location / Chicago location

When to use a new comparability plan

Generally, any employer is eligible to set up a new comparability plan.  It is most suitable for businesses with owners and principals who:

  • Want the contribution flexibility of a profit-sharing plan, and
  • Are older, on average, than their other employees and want to reward longevity and older employees, and
  • Want the biggest possible share of the plan contributions allocated to their accounts

Nondiscrimination requirements

With a new comparability plan, the percentage of the plan contributions going to the owner and other highly compensated employees can be much higher, while the cost of providing benefits to other employees can be extremely low.  The plan must pass certain nondiscrimination requirements to use this separate percentage contribution.

Contributions aren’t the only way to make a comparison for nondiscrimination purposes.  The IRS regulations permit benefits to be compared, too.  The nondiscrimination tests for new comparability plans convert contributions made to employees each year into equivalent benefits.  This is called “cross-testing.”

Essentially, cross-testing looks at the benefit a particular dollar contribution today would provide at the plan’s normal retirement age using certain actuarial assumptions.  In a new comparability plan, you must 1) provide at least required minimum contributions and 2) compare the projected retirement benefit at retirement, not at the current contribution level, for nondiscrimination testing purposes.

If the owners are the oldest employees in the group, and the majority of the non-owner employees are younger, these tests are easily passed.  If the demographics of an employee group change, the owner may not be able to take full advantage of this type of allocation.

Example: If younger employees are replaced with employees who are as old as the owners, the plan may have to provide a much higher percentage of compensation for the non-owners – almost the same percentage as the owner.

NEW COMPARABILITY EXAMPLE

DEMOGRAPHICS

ALLOCATION METHODS

Employee

Age

Salary

Salary proportional

FICA integrated

Age-weighted

New comparability

Owner 1

53

$245,000

$44,096

$47,787

$49,000

$49,000

Owner 2

47

$150,000

$26,998

$27,468

$40,438

$49,000

Employee 1

40

$52,000

$9,359

$8,314

$7,919

$2,600

Employee 2

35

$48,000

$8,639

$7,674

$4,862

$2,400

Employee 3

30

$40,000

$7,199

$6,395

$2,694

$2,000

Employee 4

28

$35,000

$6,299

$5,596

$2,003

$1,750

Employee 5

25

$32,000

$5,760

$5,116

$1,434

$1,600

Totals

 

$602,000

$108,350

$108,350

$108,350

$108,350


1
Barney, Lee. Cross-Tested Plans Shoot for Similar Benefits at Retirement.  (Plan Sponsor: February 25, 2016).

 


RSM US Wealth Management LLC does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide the aforementioned types of advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.The information provided above is for illustrative purposes and should not be interpreted to state or imply that a plan sponsor will experience similar results.  Outcomes are based on the characteristics of the plan, its participants, and plan administration.

RSM US Wealth Management Services Disclosure

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