Make Your 401(k) Work Harder for Key Employees
New comparability plans optimize the qualified plan benefit acting as both a powerful management tool and means of rewarding top-tier employees who are typically closer to retirement.
Business owners often struggle to balance a 401(k) benefit program that passes non-discrimination testing with also providing a compelling retirement compensation package to key employees. A New Comparability Plan is a surprisingly easy and overlooked profit-sharing plan design feature that enables employers to significantly increase the plan contribution for select employees who are key to company performance while remaining comfortably compliant. The design feature is simply built into employers’ existing plans; no new plan needs to be implemented.
With so much focus on potential fiduciary minefields, employers are understandably cautious about inadvertently tripping on the Internal Revenue Code restrictions on qualified plan contributions to “highly compensated employees” (HCEs). An HCE is someone who has greater than 5% ownership in a company or earns over $115,000 (2014) or was in the top 20% of compensation for employees that year. According to the Plan Sponsor Institute of America, almost 40 percent of employers have had to restrict or refund contributions to HCEs in order to pass non-discrimination testing. This scenario is not ideal for HCEs to say the least. Too often, they find they are not able to contribute as much as they would like or worse, they receive an unexpected, taxable refund of contributions at the end of the year.
What is different about a new comparability plan?
Without a new comparability plan feature, most traditional plans are distributing contributions via a “pro rata allocation”. With “pro rata allocation”, the same percent of pay is distributed to all employees, regardless of age or employee group. Some plans use an age-weighted profit-sharing method that helps older employees who have less time to save before retirement maximize their benefit; however, new comparability plans add an extra component to the equation with the “employee group” option that can be highly favorable to business owners and principals. New comparability plans dovetail especially well with safe-harbor 401(k) plans where the ability to implement more flexible HCE contribution options and still avoid non-discrimination testing is desired.
With the guidance and partnership of your qualified plan advisor, you can determine if a new comparability plan is right for your business. First, consider your employee population in terms of tenure, ages, salaries, role at the firm (professional/clerical) and turnover. Then, looking at your financial statements, total expected contribution levels and potential tax implications, you can test various scenarios to align the levels of contribution that could go to which groups of employees under a new comparability. This should be done each year and allows employers the flexibility of changing contribution levels as business conditions fluctuate.
What about fiduciary compliance?
As part of a qualified profit-sharing plan, the new comparability plan would be subject to essentially all of the same federal reporting, disclosure, limits and other requirements under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code.
The key compliance related components include, but are not limited to:
- Gateway testing
Cross testing – 401(a)(4)
- Equivalent Benefit Accrual Ratios (EBARs)
- Rate group testing
- “Top heavy” discrimination testing
Implementation steps include, but are not limited to:
- Determine plan features
- Submit to IRS for approval
- Adopt the year in which it is to go into effect
- Provide a copy of the summary plan description to all employees according to ERISA guidelines
- File the appropriate annual report with the IRS (Form 5500)
Smart business owners are always seeking new ways get the most value of their benefits plan. For employers ranging from CPA and medical practice group firms to retail and service businesses, a new comparability plan is worth exploring with your advisor.
If you’d like to take a look in further details at how a new comparability plan might benefit your business and key employees, pleaseContact Us.
About the Author
Rick Beaulieu, Jr.
Independence Financial Partners