Certainly some of the most impressive retirement plan designs for small businesses are the Cross Tested (“Comparability”) Plans.  These plans offer the business owner a substantial amount of tax deferred accumulation towards retirement, while providing an employee benefit retirement program to eligible employees.  Simply put, these plans maximize the contributions that may be made for the business owner and often minimize the contribution made for the employees.  Some of the very complex IRS rules that govern these plans are explored below.

What is a “comparability” plan?

A comparability plan is a profit sharing plan in which the contribution percentage formula for one category or class of participants is greater than the contribution percentage formula for other categories of participants.  For example, owner-participants are in one class and non-owner-participants are in another class.  Each class is then allocated a contribution, which is divided proportionately to each participant, based on compensation within the class.  All of the basic requirements that apply to regular profit sharing plans also apply to comparability cross tested profit sharing plans.  Thus, it can have a discretionary contribution formula and provide the employer with flexibility over the amount of the contribution to be made each year.  To satisfy the nondiscrimination requirements, a comparability plan is tested under the cross testing rules.

What does cross testing mean?

A qualified retirement plan may not discriminate in favor of Highly Compensated Employees (“HCE’s”) with respect to the amount of contributions or benefits.  Whether a defined contribution plan satisfies this requirement is generally determined with respect to the amount of contributions.  As an alternative, however, a defined contribution plan (other than an ESOP) may be tested with respect to the equivalent amount of benefits.  A cross tested plan must demonstrate that its contributions are nondiscriminatory every year by passing a “general test” for nondiscrimination under Internal Revenue Code §401(a)(4).

What is the minimum allocation gateway?

The IRS issued final regulations affecting cross tested plan designs that became effective for plan years beginning on or after January 1, 2002.  The final regulations require a defined contribution plan that does not provide broadly available allocation rates or certain age-weighted allocation rates to satisfy a gateway in order to be eligible to use the cross testing rules to meet the nondiscrimination requirements.   A plan satisfies this minimum allocation gateway if each NHCE in the plan has an allocation rate that is at least one-third of the allocation rate of the HCE with the highest allocation rate; however, a plan would be deemed to satisfy this minimum allocation gateway if each NHCE received an allocation of at least 5 percent of the NHCE’s compensation.  An individual who does not otherwise benefit under the plan for the plan year is not an employee for this purpose, hence not an NHCE, and need not be given the minimum required allocation under the gateway.

What is an example of a class based comparability plan?

This favorable treatment cannot be obtained in a traditional profit sharing plan.  Each employer has a unique  employee census, so please contact us for a customized quote.

Please call Hembree TPA, Inc. at (888) 486-401k or e-mail us at info@hembreetpa.com to establish a new Cross Tested Plan or review an existing Cross Tested Plan.