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The 'Cross-Tested' Approach

A new comparability or 'cross-tested' plan is an employer-sponsored, defined contribution retirement plan which favors older, long-term employees.  The plan lets an employer contribute to retirement investment accounts earmarked for each participant. Unlike traditional profit sharing plans, the participant's age, service and compensation are taken into account when determining the allocation of these contributions.  So, under a new comparability plan, the percentage of the plan contribution 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.  For a short PowerPoint presentation on Cross-Tested Plans - Click Here

  • Strategy can allow older, long-term employees to receive the annual maximum contribution for a qualified retirement plan, which is the lesser of 25% of compensation or $30,000, while younger and/or newer employees receive lesser amounts.

  • Employer costs may be lower in a new comparability plan when compared to other types of qualified pension plans - particularly defined benefit plans. 

  • Employer contributions are generally tax deductible up to 15% of 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 now. 

  • 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. 

  • Up to 15% of total eligible payroll as tax-deductible contributions. The maximum annual amount allocated for any one participant cannot exceed the lesser of 25% of a participant’s compensation from the employer or $30,000. Other limitations may apply in multiple plan situations. 

  • Since contributions are discretionary, an employer can stop, resume, increase or decrease the contributions. Actual time limitations for making such changes depend upon the plan's rules. 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.

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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 Friday, August 13, 2010 10:46 AM

 
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