This is a guest post by Tom Zgainer, Vice President of Corporate Retirement Plans for Personal Capital.
Business owners may wonder how they can skew retirement plan benefits to themselves or select top employees. The Internal Revenue Code (Code) places restrictions on the ability of a sponsor of a tax-qualified plan to do this, and a plan will not be tax-qualified if it discriminates in favor of “highly compensated” employees (HCE).
In general, such an employee is either a greater than 5% owner of the employer, or an employee that earns over $115,000 in the prior plan year. However, defined contribution retirement plan benefits can be maximized for owners or key employees through the use of a “new comparability” contribution formula to help satisfy the onerous nondiscrimination and top-heavy requirements of the Code.
An “anti-discrimination rule” applies to employer contributions made to a defined contribution retirement plan. This generally means that if an employer provides a contribution to a plan on behalf of a HCE in a certain percentage of the HCE’s compensation, then the employer must provide a contribution to the plan on behalf of a non-HCE in the same percentage of compensation. This is known as a “pro rata allocation.”
By comparison, new comparability plans are more beneficial to the employer. This is because they provide a maximum benefit for the HCEs or select employee group, while providing the lowest possible contribution for the non-HCEs or non-key group allowed by law. Since the select employees are often the business owner(s) and are older, they have less time to reach retirement age than do younger employees. Therefore, the select employees may receive a disproportionately greater share of contributions under this doctrine. Plans can be nondiscriminatory and the tax-qualification rules of the Code are proved to be satisfied.
Have questions about your company’s 401k plan? Email [email protected]
Want to learn more about Personal Capital’s 401k? Visit PersonalCapital401k.com.
The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.
Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.