New Comparability Profit Sharing Plans: The Basics

in Retirement Planning by

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]

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