The final regulations kept the elements of proposed regulations on cross-testing, or so-called new comparability, plans issued on October 5, 2000.
These programs are designed to provide higher profit-sharing rates to highly paid employees. New comparability plans are cross-tested on a projected-benefits basis to meet nondiscrimination rules.
Current rules allow employer contributions to be tested on either a present-value basis or cross-tested on a future-value basis that involves projecting benefits that would be payable at retirement. Cross-testing lets a defined contribution plan be tested like a defined benefit plan, essentially focusing not on the current rate of contribution, but on what a particular contribution for a given employee is projected to be – with interest – as an annual benefit paid when the employee reaches age 65.
The primary addition in the final regulations is a limit on the minimum allocation rate that combined plans are required to provide to nonhighly compensated employees under one cross-testing requirement.
Combined Plans Cap
According to BNA, the proposed regulations allowed combined plans to satisfy cross-testing requirements if they are:
- primarily defined benefit in character
- consist of broadly available separate plans, or
- pass a minimum allocation gateway
That gateway occurs when:
- each nonhighly compensated employee in the plan has an allocation rate that is at least one-third of the allocation rate of the highly compensated employee with the highest allocation rate (if the highest rate is less than 15%, percent)
- the allocation rate for all nonhighly compensated employees is least 5% (if the highly compensated employee rate is between 15% – 25%) or
- the allocation for each nonhighly compensated employee is least 5% plus 1 percentage point for each 5 percentage point increment (or portion thereof) by which the highly compensated employees rate exceeds 25%
The final regulations said the allocation rate that combined plans are required to provide for non-highly compensated employees need not exceed 7 1/2% of pay. The imposition of such a limit was recommended as necessary in order to avoid leading to the abandonment of defined contribution plans by employers.
Proposed Rules Expanded
The proposed regulations allowed defined contribution plans to satisfy cross-testing requirements if the plans provided broadly available allocation rates, age-based allocations, or an allocation rate for nonhighly compensated employees that is at least 5 percent of compensation or one-third the highest allocation rate for highly compensated employees–referred to as the minimum allocation gateway.
The proposed regulations also said a defined contribution plan that makes each allocation rate available to a group of employees that satisfies tax code Section 410(b), without regard to the average benefit percentage test, would be treated as having broadly available allocation rates and could use nondiscrimination testing.
The final regulations retain these requirements, and additionally permit two allocation rates to be aggregated such that nonhighly compensated employees with a higher allocation rate can be used to support a lower allocation rate.
The final regulations also allow uniform target benefit plans that do not comply with the safe harbor testing method under Treasury Regulations Section 1.401(a)(4)-8(b)(3) to satisfy the age-based allocations requirement.
In addition, the final regulations broaden the age-based allocations requirement to accommodate plans that achieve a smoother progression into higher rates based on the sum of age and years of service.
For MORE on comparability plans, see our PLAN DESIGN Solutions topic .
See Also The New Comparability Formula .