How do new comparability plans help employers?
Retirement plans—in general—play an important role in helping you attract and retain talented employees. New comparability plans can help with that effort under certain circumstances. They can be a great fit for employers that have owners and highly compensated employees (HCEs) who are older, on average, than the company’s other employees—and, therefore, have a shorter time horizon to get ready for their retirement years. There are several advantages to the employer, including:
- Maximizing contributions: Business owners or other targeted employees may receive amounts up to the annual IRS DC retirement plan limits.
- Flexibility: Employers can change contributions annually—increasing them, decreasing them, or stopping them altogether.
- Tax deductibility: Employer contributions are generally tax deductible.
New comparability plans may not be ideal for companies with large fluctuations in their workforce, as large demographic or workforce size changes could have an impact on funding cost and/or the ability to achieve funding objectives.
How do new comparability plans work for small businesses?
The best way to explain how they work is with an example. Let’s look at the choices the owners of a dental office have for their practice’s retirement plan.
- They can offer a traditional 401(k) plan, which gives all employees a 5% of eligible pay contribution.
- Or they can choose a new comparability plan, which offers them—as owners and HCEs (older groups, on average)—a much larger share of the plan’s annual contributions.
|Role||Traditional 401(k) plan contribution (5% of eligible pay)||New comparability plan contribution (based on role)|
$285,000 annual salary
$285,000 annual salary
$90,000 annual salary
$80,000 annual salary
$55,000 annual salary
Dental assistant 1
$55,000 annual salary
Dental assistant 2
$50,000 annual salary
Front desk administrator
$45,000 annual salary
$60,000 annual salary
For illustrative purposes only.
Traditional retirement plan versus new comparability plan
The key benefit of a new comparability plan is that it gives HCEs a bigger share of the annual employer contribution than the non-HCEs, but it’s still considered nondiscriminatory under the law.
|Traditional plan (5%)||New comparability plan|
|Contribution to owners||$28,500||$51,100|
|% of total allocation||57%||78%|
The plan still has to pass nondiscrimination testing
New comparability plans, like other retirement plans, must pass a series of tests to determine whether they’re nondiscriminatory—and that they benefit employees in a nondiscriminatory way. Those tests include:
- A minimum allocation gateway test, which is the most common prerequisite to meeting nondiscrimination testing standards through cross-testing, or testing DC amounts as benefiting percentages at normal retirement age (NRA). This will test whether all non-HCEs benefiting from profit sharing equal the lesser of one-third of the highest rate an HCE receives or 5%.
- General nondiscrimination testing (often referred to as new comparability testing) involves applying minimum coverage testing principles to every rate group, as defined by testing criteria. A rate group exists for every HCE and all others benefiting at the same or higher testing rate. Each rate group must yield a nondiscriminatory ratio of HCEs and non-HCEs benefiting from that testing rate.
- Cross-testing—Most often, testing rates are developed by converting contributions into projected benefit amounts at NRA. Those amounts are then converted into a single life annuity and divided by compensation to form a testing percentage. These rates are generally referred to as equivalent benefiting ratios (EBARs). Generally, cross-testing is very effective, as non-HCE populations are usually much younger than their HCE counterparts. In converting to EBARs, a reasonable rate of interest is applied to each individual’s contribution amount for the years until NRA is reached; younger participant contribution amounts are, therefore, disproportionately amplified.
- Other 401(k) nondiscrimination tests also apply, including actual deferral percentage, actual contribution percentage, and 402(g) limits.
When you’re offering a new comparability plan, it’s a good practice to perform testing before contributions are funded to be sure allocations are nondiscriminatory.
Is a new comparability plan right for your business?
New comparability plans may make the most sense for businesses that want to maximize their employer contributions to older, higher-paid owners and key employees while still rewarding their younger workers. A benefits or financial professional can review your options with you and recommend a retirement plan structure that meets the needs of your business, owners, and employees.
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.