A cross-tested, or new comparability, plan is a type of profit-sharing plan that permits the sponsor to divide employees into different groups and project what a current contribution would amount to at retirement age, opening up the possibility of rewarding older employees with higher-dollar contributions, says Adam Pozek, a partner with DWC—The 401(k) Experts, a third-party plan administrator in St. Paul, Minnesota.
The structure works by taking into account benefit accrual rates, says Rob Massa, director of retirement at Ascende Wealth Advisers in Houston. “This takes age into account, enabling the contributions allocated to older employees to be larger than those made to younger employees” because the older employees have fewer years before retirement, Massa says. For 2017, the maximum amount that can be contributed to a worker is $54,000, says Lori Shannon, a partner with Barnes & Thornburg in Chicago.
These are the type of benefit accrual rates that are applied to defined benefit plans, says Ronald Cluett, of counsel at Caplin & Drysdale in Washington, D.C. “Cross-tested plans are the opposite of a safe harbor plan where the employer makes a uniform contribution for every participant,” Cluett says. “They are at the other end of the spectrum.”
New comparability plans are the next generation of age-weighted plans, says Tom Foster, head of strategic relationships for MassMutual’s Workplace Solutions in Enfield, Connecticut. “One of the problems with age-weighted plans is that if you have an owner and a worker who are both 50, both would get the same contribution,” Foster says. “With a cross-tested plan, you can divide the company into different worker groups that would allow the 50-year-old owner to get a greater allocation than the 50-year-old worker. These plans are beneficial for owners and yet give a meaningful allocation to workers, because the minimum they must give to the workers is either 5% of pay or one-third of the amount allocated to the most highly compensated worker.”
Cross-tested plans can be paired with a cash balance plan, Foster says. However, if the employer contributes another 2.5%, or 7.5% to the cross-tested and cash balance plan, they earn the right to exclude 40% of their workforce or 50 employees from the cash balance plan, whichever is less, Foster says. “This gives the sponsor a lot of flexibility,” he says.
Employers will typically use cross-tested plans to reward employees for their longevity or to help older workers who have less time to accumulate assets, says Paula Calimafde, a partner with Paley Rothman in Bethesda, Maryland. “It is a way for the company to fine tune the plan to use it as a retention tool to keep the employees it feels are important to the success of the company,” she says. These plans also have a “last day of service requirement,” so that if an employee moved over into another category, the employer can change their contribution, she says.
Cross-tested plans are most common among small, professional organizations such as physicians’ offices, law firms or engineering firms, where there is a disparity in compensation, says Sherri Painter, senior vice president at PNC Retirement Solutions in Pittsburgh, Pennsylvania.
There are some downsides to cross-tested plans, Pozek says. Because the benefit accrual rates project what a current contribution will become at retirement, demographic shifts in an employer’s workforce can change the results, so they need to be tested at least once a year, he says.
Some critics also say that cross-tested plans unfairly reward the owners of a company, but the 5% minimum contribution is actually far higher than company matches found in most 401(k) plans, Pozek notes. The company also needs to be sure that it can afford the commitment to the 5% contribution, which is “a pretty significant amount,” Foster notes.
Furthermore, “once you go outside a straight profit-sharing plan, there are additional third-party administrator (TPA) costs related to the number of employee groups you set up,” Foster says. “The TPA has to be careful that they are setting up the groups within the statutory guidelines.”