New Comparability Plans
A retirement plan alternative that favors key employees

By Jeffrey S. Smith

 If you’re looking for a retirement plan with the tax advantages of a qualified plan along with the ability to skew employer contributions toward key and highly compensated employees (HCEs), you may be frustrated by the apparent lack of alternatives available. The regulations governing qualified retirement plans generally stipulate that a plan cannot be designed to discriminate in favor of HCEs,* as defined by the IRS. However, you may find what you’re looking for in a new comparability plan, also referred to as a cross-tested plan.

Is It Right For Your Business?
A new comparability plan is best suited for employers for which the key employee groups targeted to receive large contributions are, on average, older and highly compensated.  A new comparability plan is probably not suited for businesses where:

1. The employee group targeted to benefit is younger

2. Rank-and-file employees are, for the most part, older

3. The business has few or no rank-and-file employees and experiences a high turnover rate

What Is A New Comparability Plan?
New comparability plans are a type of defined-contribution plan allocation that lets an employer designate different contribution percentages to favor select groups of employees. This allocation is one of the few ways a plan sponsor can allow select employee groups to potentially receive the maximum employer contribution and contribute up to the annual employee-contribution limit while reducing the amount of employer contributions going to rank-and-file employees.†

How New Comparability Plans Work
“Cross testing” separates new comparability from other contribution-allocation methods in defined-contribution plans. Cross testing is when an allocation for a plan participant is converted into a projected benefit at retirement. When determining the allocation for a particular year’s contribution, the business must establish a desired projected benefit at retirement (typically age 65). A plan is not considered discriminatory as long as when the contributions are cross-tested converted into a projected benefit — each individual has the same projected retirement benefit.

When performing the cross-testing calculation, employees are divided into defined groups. For example, a plan sponsor can separate its employees into HCEs and non-highly compensated employees (NHCEs) or by specific job classifications, such as owners, sales and clerical. The employer can then make separate contributions with respect to each group. Cross testing is more commonly used with defined-contribution plans, such as profit sharing plans, or as a profit-sharing contribution to a 401(k).

Benefits Of Cross Testing
A cross-tested plan permits substantially larger contributions for groups of older
participants than for those who are younger, as larger contributions must be made for older employees because there’s less time for them to potentially accumulate and reach the desired projected benefit.

If you have a younger employee whom you’d like to group with the older employees, a new comparability plan lets you do so as long as the average age for that group remains older than that of the other groups.

Challenges Of Cross Testing
Cross testing is complex. Although you are not required to employ an actuary (as you would with a defined benefit plan) to perform the cross-testing calculations, employers are strongly encouraged to hire a third-party administrator that specializes in new comparability plans. Typically, the new comparability feature will add to the plan’s administrative costs. However, for many businesses, the employer receives an increased share of the plan's contributions, which off sets the additional costs (depending on the employee demographics).

Is New Comparability Right For You?
A new comparability plan is clearly not for every employer. Unless your employees’ ages happen to conveniently break down so that you can create the desired groups, the plan will not generate the intended results. However, when employee demographics do work out and the employer is willing to pay the additional costs, a new comparability plan can be a viable retirement plan solution.

For Example:
Sam’s business has four employees (including Sam). He is 55 years old and the business’s only HCE. As a result, Sam can be in a “group” by himself. As the table below shows, by using new comparability versus traditional profit sharing, a significantly larger portion of the business’s contribution would go to him rather than the other employees.

New comparability plan versus traditional profit sharing

Example assumes 1) The business is incorporated and 2) the plan uses a one-year-of-service eligibility provision.

About the Author
Jeffrey S. Smith, Vice President-Investments, Senior Institutional Consultant with Wells Fargo Advisors, has over 15 years experience as a financial advisor, and is dedicated to helping his clients meet their financial goals. Jeffrey is a Certified Investment Management Analyst℠ professional (CIMA®), and a member of the Investment Management Consulting Association (IMCA). He can be reached at jeffrey.smith5@wfadvisors.com and his website is www.jeffreysmith.wfadv.com

This publication is designed to provide accurate and authoritative information regarding the subject matter covered. It is made available with the understanding that Wells Fargo Advisors are to engaged I rendering legal, accounting or tax-preparation services. If tax or legal advice is required, the services o a competent professional should be sought. Wells Fargo’s’ view is that investment decisions should be based on investment merit, not solely on tax considerations. However, the effects of taxes are a critical factor in achieving a desired after-tax return on your investment. The information provided is based on internal and external sources that are considered reliable; however, the accuracy of the information is not guaranteed. Specific questions on taxes as they relate to your situation should be directed to your tax advisor.

Investments and insurance products: NOT FDIC-Insured, NO Bank Guarantee, MAY Lose Value Wells Fargo Advisors, LLC, Member SPIC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company. * If it’s determined that a plan does discriminate, the plan can not take advantage of the favorable tax treatment available with qualified retirement plan. Non discrimination testing and gateway minimum testing apply.