NEW COMPARABILITY PLANS

A new comparability plan is generally a profit sharing plan or a money purchase pension plan in which the contribution percentage is different for various classes of employees. A new comparability plan is designed to satisfy nondiscrimination requirements under cross-testing rules, wherein the contributions for the individual participants are compared using actuarial projections of future monthly benefits payable at normal retirement age. The calculated equivalent benefit accrual rates (EBARs) are tested on a benefits basis for nondiscrimination, as a defined benefit pension plan would. For these reasons, a new comparability plan is often referred to as a tiered plan or a cross-tested plan. The outcome of cross-testing is that younger employees have relatively high testing EBARs (see illustration under the “Example” section), thereby allowing the employer to reward with larger contributions certain classes of employees who are on average older than other classes of employees. Most new comparability plans are designed as profit sharing plans. Therefore, this article will reference a profit sharing plan when applying the term “new comparability plan.”

ADVANTAGES

• Allows an employer to reward classes of employees that it considers more valuable
• Older employees who are closer to retirement, especially owners, may receive higher contributions
• Even though a new comparability plan is tested virtually as a defined benefit pension plan, it is not required to be certified by an actuary or be covered by the Pension Benefit Guaranty Corporation’s (PBGC) federal pension insurance program
• Employer contributions to a profit sharing plan are discretionary
• A new comparability plan can be designed as a profit sharing plan containing a 401(k) arrangement. It can also utilize the safe harbor option for meeting the nondiscriminatory requirements that pertain to 401(k) arrangements. Furthermore, safe harbor non-elective contributions can be used to satisfy the gateway requirements
• A new comparability plan may adjust the benefit accrual rates for permitted disparity (Social Security benefits) when cross-testing for nondiscrimination
• A profit sharing plan may permit early withdrawals (for instance, under certain hardship circumstances) and plan loans
• A profit sharing plan may be adopted by tax-exempt entities, churches and governmental entities

POSSIBLE DISADVANTAGES

• Under gateway rules, non-highly compensated employees must usually receive a contribution equal to 5% of their plan compensations. This contribution amount can be lower only if the highest allocation rate for a highly compensated employee is less than 15%
• The employer is expected to make “substantial and recurring” contributions to a profit sharing plan
• Deduction limits are lower than in a defined benefit pension plan
• The level of benefits that may be provided is potentially not as high as in a defined benefit pension plan
• There are limited restrictions on the withdrawal of profit sharing funds, for example, generally speaking, the profit sharing contributions must have been in the plan for two years before they can be withdrawn, and only if the document allows it

ANALYSIS

• The Internal Revenue Service has indicated that it is acceptable and nondiscriminatory to place each eligible participant in a separate tier for allocation purposes, and has been approving plan documents with such provisions.
• The gateway allocation is triggered when a participant is eligible to receive any employer non-elective contribution at all. Therefore, much dexterity and knowledge are to be exercised in designing such a plan in order to avoid the pitfall of an unexpectedly hefty contribution liability, especially in a plan that is top-heavy, allows 401(k) employee elective contributions or has multiple eligibility requirements.
• A new comparability plan can be combined with a defined benefit pension plan sponsored by the employer. The combination must satisfy additional requirements. It must either (a) be primarily defined benefit in character, or (b) consist of broadly available separate plans, or (c) make a gateway contribution to all eligible non-highly compensated participants, in many cases equal to 7.5% of compensation.
• With the imminent Social Security crunch, it is anticipated that legislators will provide more relief to private pension plan sponsors. The Congress appears unlikely to pass laws that make it tougher for private employers to sponsor attractive plans such as new comparability plans.

EXAMPLES(S)

Comparison of various allocation formulas:

Calculation of equivalent benefit accrual rates (EBARs):

CONCLUSION

Proponents of new comparability plans have praised them as a means of inducing small employers to cover their employees in a qualified plan. Detractors point out that a huge chunk of contributions in a new comparability plan, up to 90% in some instances, is made to the accounts of highly compensated employees, making it discriminatory in operation. In any event, a new comparability plan may work well for certain large employers, but it undeniably merits solid consideration from small to medium employers who covet the flexibility of a profit sharing plan, the ability to target principal employees who are typically older, and want to keep the cost of their employee benefits manageable. Employers who wish to reward their principals or key employees at different levels of benefit in different years should keep a new comparability plan in mind as well.