Creative Uses for Cross-Tested Retirement Plans

Creative Uses for Cross-Tested Retirement Plans

By Randall W. Cook

As we have reported in past issues of “Business Briefs,” cross-tested retirement plans are a unique form of profit sharing plan that allow employers to allocate considerably higher plan contributions to one or more select groups of employees. In many instances, the select group of employees chosen by the employer will be the “highly compensated” employees (i.e., employees who are owners of the company, or who earn $85,000 or more per year). Although this may be the most common use of cross-tested plans, it is by no means its only use.

One of the most beneficial uses of a cross-tested plan is to allocate plan contributions on a basis that has nothing to do with an employee’s status as a highly compensated employee. Treating employees differently is commonplace in today’s workforce; few employers pay all of their employees the exact same wage and/or bonus each year. Rather, wages and bonuses are typically determined as a function of the employee’s relative worth to the company. Why, then should each employee’s retirement plan contribution be the exact same?

Consider, for example, a cross-tested plan that creates job classes based on years of service with the employer. Under such a plan, the employer might decide to give employees with less than five years of service a 5% contribution, employees with five to ten years of service an 10% contribution, and employees with more than ten years of service a 15% contribution. Alternatively, the employer might create job classes based on work duties (e.g., “production line” employees receiving a 5% contribution, versus “office employees” receiving a 10% contribution).

Cross-tested retirement plans can also be a valuable tool in overcoming some of the shortfalls in 401(k) plans. One such shortfall is the fact that wages deferred by an employee into the 401(k) portion of a retirement plan are subject to Social Security taxes. By contrast, profit sharing amounts contributed by the employer on the employee’s behalf do not constitute FICA wages, and therefore are not subject to Social Security taxes.

This can present an important planning opportunity when hiring employees. Utilizing a cross-tested plan can allow an employer to offer select employees a total benefit package that, although lower in current compensation, may be much higher in profit sharing contributions than other employees. This saves both the employer and the employee Social Security taxes. To the extent that the employee who receives the higher allocation is a highly compensated employee, it also avoids the “average deferral percentage test” limitations that often accompany 401(k) plans.

With the advent of cross-tested retirement plans, employers now have the ability to tailor retirement plan benefits to the specific demographics of their workforce. Please call if you would like more information.