Cross tested plans - how-to & examples

J
Jim van IwaardenJim van Iwaarden
Cross-Tested Plans 
James A . van I waarden, F S A , E A 
Con s u l t i ng A c t u a r y 
Van I wa a rde n A s s o c i a tes 
Minneapo l is, MN 
ISCEBS Sympo s ium, B o s ton 
Sep tember 2 5 , 2 013
Today’s Menu 
y What are cross-tested plans? 
y History 
y Cross-testing “recipe” 
y Plan designs 
y Other uses 
y What works, what to avoid 
y How to use cross-tested plans with 401(k)’s
What are Cross-Tested Plans? 
y Plans that don’t fit into 
IRS pre-approved 
designs 
y Or...a group of non-identical 
plans 
y Show nondiscrimination 
by converting 
contributions into 
benefits (cross) and 
testing the benefits 
(testing!)
History of Cross-Testing – Part I 
§401(a)(4) 
•...benefits or 
contributions 
do not 
discriminate 
in favor of 
HCEs... 
RR 81- 
202 
•comparability 
of plans 
410(b) & 
401(a)(4) 
regs 
•200+ pages, 
early 1990’s
History of Cross-Testing – Part II 
New 
Comparability 
•a.k.a. class 
allocation plans, 
based on the new 
regulations 
Threats to 
outlaw 
• led to “gateways” 
effective 2002 
Stable for 
10+ years 
•now, even 
prototype plans 
include class 
allocation option
Cross-Testing “Recipe” for DC Plans 
Step 1: pass thru any of three “gateways” 
Go! 
Broadly available 
allocation rates 
Gradual age or 
service schedule 
Minimum alloc rate: 
5% or 1/3 top HCE
Cross-Testing “Recipe” for DC Plans 
y Step 2: prepare the ingredients 
@ 8½% 
interest 
Contribution 
for each ee 
To age 
65 
÷ annuity factor (we’ll use 10) to get annual benefit 
÷ pay = accrual rate
Cross-Testing “Recipe” for DC Plans 
y Step 3: mix it all together 
There’s a rate group for each HCE; 
it includes the HCE & everyone 
(HCE or NHCE) with a higher 
accrual rate: 
ees w/ rate 
>=HCE#1 
HCE#1 
Test each rate group to see if it passes 
the §410(b) coverage test: 
• 70% ratio percentage test, or 
• average benefit percentage test 
Ratio % below is 75% ÷ 50% = 150% 
%/HCEs 
2/4=50% 
%/NHCEs 
3/4=75%
Cross-Tested Plan Designs 
y Common designs include: 
{ Age-weighted: guaranteed to pass 
{ Service-weighted 
{ Class allocation (aka “new comparability”) 
{ DB/DC, usually cash balance & profit sharing 
{ Examples for Dr. F & his faithful servants...
Cross-Tested Plan Designs 
y Age-weighted profit sharing plan 
{ Always passes §401(a)(4) test, but not very flexible 
{ Gateway is gradual age or service schedule 
{ One rate group covers HCE (Dr. F) & both NHCEs, ratio % = 100% 
Age Service Pay PS % PS $ 
Benefit 
Accrual 
Rate 
Dr. Frankenstein 60 40 $255,000 20% $51,000 3.01% 
Igor 40 10 50,000 3.91% 1,955 3.01% 
Inga 30 5 30,000 3%* 900 5.22% 
* Age-weighted formula produces 1.73%, but 3% top-heavy minimum applies.
Cross-Tested Plan Designs 
y Service-weighted profit sharing plan 
{ Rewards loyalty, not very common 
{ PS in this example is ½% of pay per year of service 
{ Gateway is gradual age or service schedule 
{ One rate group covers HCE (Dr. F) & both NHCEs, ratio % = 100% 
Age Service Pay PS % PS $ 
Benefit 
Accrual 
Rate 
Dr. Frankenstein 60 40 $255,000 20% $51,000 3.01% 
Igor 40 10 50,000 5% 2,500 3.85% 
Inga 30 5 30,000 3%* 900 5.22% 
* Service-weighted formula produces 2.5%, but 3% top-heavy minimum applies.
Cross-Tested Plan Designs 
y Class allocation (aka “new comparability”) profit sharing 
{ Very common, even prototype documents include this option 
{ Gateway is minimum allocation 5% or 1/3 of highest HCE rate 
{ One rate group covers HCE (Dr. F) & both NHCEs, ratio % = 100% 
Age Service Pay PS % PS $ 
Benefit 
Accrual 
Rate 
Dr. Frankenstein 60 40 $255,000 20% $51,000 3.01% 
Igor 40 10 50,000 5% 2,500 3.85% 
Inga 30 5 30,000 5% 1,500 8.69%
Cross-Tested Plan Designs 
y DB/DC combo: cash balance & profit sharing 
{ Common for professional firms 
{ Enables large deductible contributions for owners 
{ Gateway here is 7½% DC; Igor & Inga get 3% cash balance credits 
{ This example is for a PBGC-covered plan, Frankenstein Mfg. Inc. 
Ù A PBGC-exempt professional firm may need to limit DC er contrs to 6% 
Age Pay 
Cash 
Balance 
Credit 
PS & 
3% Safe 
Harbor 
401(k) & 
Catchup Total 
Dr. F’stein 60 $255,000 $230,000 $33,500 $23,000 $286,500 
Igor 40 50,000 1,500 3,750 whatever 5,250+401k 
Inga 30 30,000 900 2,250 whatever 3,150+401k
Other Uses for Cross-Testing 
y Can structure retirement plans by business unit 
y Could be all DB, all DC or a combination 
y It’s a lifesaver for mergers & acquisitions
Other Uses for Cross-Testing 
y Case study: parent & acquisitions, 25,000 total ees 
DB/DC DB only DC only 
y Combine all the plans and test on a benefits basis 
y Can apply this for any group of non-identical plans
Cross-Testing – What Works, What to Avoid 
y What works great 
{ Profit sharing / cash balance combination 
Ù PS projected at 8½% interest 
Ù Cash balance at interest crediting rate (usually much lower) 
Ù Better results than pure DB or pure DC 
Ù Effect is known as
Cross-Testing – What Works, What to Avoid 
y What works great 
{ 401(k) 3% safe harbor 
{ You get a triple dip 
Ù Free pass for ADP & ACP tests 
Ù Covers DC top-heavy requirement 
Ù Counts for cross-testing base & gateway 
{ A few issues 
Ù Notice required >30 days before plan year starts 
Ù 100% vesting 
Ù Can’t impute “permitted disparity” (FICA recognition) for testing 
{ Add profit sharing, if needed to meet gateway
Cross-Testing – What Works, What to Avoid 
y What to avoid 
{ Unfavorable demographics 
Ù HCEs younger than others 
Ù Usually a solution, but it’s tricky 
{ Inflexible plan designs 
Ù Contribution rates specified in plan document 
Ù Even prototypes now allow each participant in own class
Cross-Testing – What Works, What to Avoid 
y What to avoid 
{ Failing the §401(a)(4) test! 
{ Causes 
Ù Demographic changes, especially new young HCEs 
Ù Inflexible plan designs 
{ Prevention 
Ù Test before contributing 
Ù Flexible plan designs 
{ Cure 
Ù §1.401(a)(4)-11(g) corrective amendment 
Ù Can provide extra contributions for a targeted group of NHCEs 
Ù Must be done within 9½ months after end of year
Cross-Testing – What Works, What to Avoid 
y What to avoid 
{ 401(k) matching contributions (even safe harbor) 
{ Really? 
{ Deferrals & match don’t count for 1st stage of §401(a)(4) test 
{ You can still match, but it’s an extra expense 
{ What can you do? 
Ù Convert match to 3% safe harbor, with advance notice 
Ù Add profit sharing for gateway & cross-testing base
Using Cross-Tested Plans with 401(k)’s 
y Get top people within deferral range of §415 DC maximum 
{ In 2013, that’s $51,000 - $17,500 = $33,500 (13.14% of max pay) 
y Cover the gateway for NHCEs 
{ If HCEs are at 13.14%, NHCEs need to be at 1/3 of that: 4.38% 
y Use 3% non-matching safe harbor 
{ That leaves only 1.38% needed for NHCE profit sharing 
{ Frees HCEs to maximize 401(k) deferrals 
y Still need to run the test 
{ But gateway is often enough to pass 
20% 
15% 
10% 
5% 
0% 
NHCE HCE 
Def 
PS 
SH
Take-Out Menu 
y Cross-testing is the most powerful testing tool there is! 
y You can structure plans to fit business needs 
y It makes some amazing plan designs possible
1 of 22

Recommended

Cash balance & hybrid plans final & proposed reg by
Cash balance & hybrid plans   final & proposed regCash balance & hybrid plans   final & proposed reg
Cash balance & hybrid plans final & proposed regJim van Iwaarden
1.1K views17 slides
Market based cash balance plans by
Market based cash balance plansMarket based cash balance plans
Market based cash balance plansJim van Iwaarden
943 views21 slides
Cash balance and hybrid plans - final and proposed regulations by
Cash balance and hybrid plans - final and proposed regulationsCash balance and hybrid plans - final and proposed regulations
Cash balance and hybrid plans - final and proposed regulationsJim van Iwaarden
183 views17 slides
ADP/ACP Testing - Back To Basics & Then Some by
ADP/ACP Testing - Back To Basics & Then SomeADP/ACP Testing - Back To Basics & Then Some
ADP/ACP Testing - Back To Basics & Then SomeAdam Pozek
5.2K views68 slides
Costing Your Grant - A presentation by
Costing Your Grant - A presentationCosting Your Grant - A presentation
Costing Your Grant - A presentationmds-rkto
313 views16 slides
WACC. Mng. Fin by
WACC. Mng. FinWACC. Mng. Fin
WACC. Mng. FinArman Hossain Ab
363 views19 slides

More Related Content

Viewers also liked

2009 pension funding regulations by
2009 pension funding regulations2009 pension funding regulations
2009 pension funding regulationsJim van Iwaarden
851 views26 slides
сAshmob at glance by
сAshmob at glanceсAshmob at glance
сAshmob at glanceMiguel Aprossine
395 views22 slides
24symbols - Walk-through for Publishers by
24symbols - Walk-through for Publishers24symbols - Walk-through for Publishers
24symbols - Walk-through for Publishers24Symbols
457 views15 slides
Valvular Heart Disease by
Valvular Heart DiseaseValvular Heart Disease
Valvular Heart DiseasePk Doctors
2.6K views19 slides
The selena's by
The selena'sThe selena's
The selena'sgzorskas
219 views9 slides
Fab friday ppt by
Fab friday pptFab friday ppt
Fab friday pptHart County BOE
267 views8 slides

Viewers also liked(16)

Similar to Cross tested plans - how-to & examples

CAA 2016 PBR by Cardinal & Jiang (revised) by
CAA 2016 PBR by Cardinal & Jiang (revised)CAA 2016 PBR by Cardinal & Jiang (revised)
CAA 2016 PBR by Cardinal & Jiang (revised)He Jiang
257 views28 slides
Survey of Finance and Engineering Economics Presented byMoha.docx by
Survey of Finance and Engineering Economics Presented byMoha.docxSurvey of Finance and Engineering Economics Presented byMoha.docx
Survey of Finance and Engineering Economics Presented byMoha.docxmattinsonjanel
6 views179 slides
Combo Design Presentation by
Combo Design PresentationCombo Design Presentation
Combo Design PresentationRetirement_Plan_Specialists
944 views24 slides
Rick Pummill - TRPC - Effective Plan Design and Administration by
Rick Pummill - TRPC - Effective Plan Design and AdministrationRick Pummill - TRPC - Effective Plan Design and Administration
Rick Pummill - TRPC - Effective Plan Design and AdministrationDowney Brand LLP
1.5K views37 slides
See the You Decide content item for details, instructions, and gra.docx by
See the You Decide content item for details, instructions, and gra.docxSee the You Decide content item for details, instructions, and gra.docx
See the You Decide content item for details, instructions, and gra.docxkenjordan97598
3 views12 slides
wp-pm-an-ounce-of-prevention by
wp-pm-an-ounce-of-preventionwp-pm-an-ounce-of-prevention
wp-pm-an-ounce-of-preventionJed DeGroote
130 views13 slides

Similar to Cross tested plans - how-to & examples(20)

CAA 2016 PBR by Cardinal & Jiang (revised) by He Jiang
CAA 2016 PBR by Cardinal & Jiang (revised)CAA 2016 PBR by Cardinal & Jiang (revised)
CAA 2016 PBR by Cardinal & Jiang (revised)
He Jiang257 views
Survey of Finance and Engineering Economics Presented byMoha.docx by mattinsonjanel
Survey of Finance and Engineering Economics Presented byMoha.docxSurvey of Finance and Engineering Economics Presented byMoha.docx
Survey of Finance and Engineering Economics Presented byMoha.docx
mattinsonjanel6 views
Rick Pummill - TRPC - Effective Plan Design and Administration by Downey Brand LLP
Rick Pummill - TRPC - Effective Plan Design and AdministrationRick Pummill - TRPC - Effective Plan Design and Administration
Rick Pummill - TRPC - Effective Plan Design and Administration
Downey Brand LLP1.5K views
See the You Decide content item for details, instructions, and gra.docx by kenjordan97598
See the You Decide content item for details, instructions, and gra.docxSee the You Decide content item for details, instructions, and gra.docx
See the You Decide content item for details, instructions, and gra.docx
kenjordan975983 views
wp-pm-an-ounce-of-prevention by Jed DeGroote
wp-pm-an-ounce-of-preventionwp-pm-an-ounce-of-prevention
wp-pm-an-ounce-of-prevention
Jed DeGroote130 views
Success Strategies in School Capital Planning by SchoolDude
Success Strategies in School Capital PlanningSuccess Strategies in School Capital Planning
Success Strategies in School Capital Planning
SchoolDude774 views
Th14 Balanced Testing Presentation by Edwin Loon, van
Th14   Balanced Testing   PresentationTh14   Balanced Testing   Presentation
Th14 Balanced Testing Presentation
Edwin Loon, van388 views
WW14 Presentation - Sustain Energy Reductions thru CCx and Behavior Modificat... by Michael Cook
WW14 Presentation - Sustain Energy Reductions thru CCx and Behavior Modificat...WW14 Presentation - Sustain Energy Reductions thru CCx and Behavior Modificat...
WW14 Presentation - Sustain Energy Reductions thru CCx and Behavior Modificat...
Michael Cook466 views
Monetizing Risks - A Prioritization & Optimization Solution by Black & Veatch
Monetizing Risks - A Prioritization & Optimization SolutionMonetizing Risks - A Prioritization & Optimization Solution
Monetizing Risks - A Prioritization & Optimization Solution
Black & Veatch1.4K views
Features of Successful Inclining Block Water Conservation Rate Structures by The Texas Network, LLC
Features of Successful Inclining Block Water Conservation Rate StructuresFeatures of Successful Inclining Block Water Conservation Rate Structures
Features of Successful Inclining Block Water Conservation Rate Structures
CRJ 200 Criminal Procedure and Criminal EvidenceDirections Pro.docx by faithxdunce63732
CRJ 200 Criminal Procedure and Criminal EvidenceDirections Pro.docxCRJ 200 Criminal Procedure and Criminal EvidenceDirections Pro.docx
CRJ 200 Criminal Procedure and Criminal EvidenceDirections Pro.docx
Successfully Achieving And Delivering Results Through Rigorous Project Select... by shawncarner
Successfully Achieving And Delivering ResultsThrough Rigorous Project Select...Successfully Achieving And Delivering ResultsThrough Rigorous Project Select...
Successfully Achieving And Delivering Results Through Rigorous Project Select...
shawncarner488 views
Webinar: Work and Health Programme - How you can stand out by Policy in Practice
Webinar: Work and Health Programme - How you can stand outWebinar: Work and Health Programme - How you can stand out
Webinar: Work and Health Programme - How you can stand out
Policy in Practice451 views

More from Jim van Iwaarden

GASB 75 Implementation Issues by
GASB 75 Implementation IssuesGASB 75 Implementation Issues
GASB 75 Implementation IssuesJim van Iwaarden
146 views31 slides
Pension & OPEB Funding Strategies for Illinois Public Plans by
Pension & OPEB Funding Strategies for Illinois Public PlansPension & OPEB Funding Strategies for Illinois Public Plans
Pension & OPEB Funding Strategies for Illinois Public PlansJim van Iwaarden
172 views30 slides
The Alphabet Forest: OPEB, GASB and Pensions by
The Alphabet Forest: OPEB, GASB and PensionsThe Alphabet Forest: OPEB, GASB and Pensions
The Alphabet Forest: OPEB, GASB and PensionsJim van Iwaarden
122 views28 slides
GASB 74/75 OPEB Accounting Changes by
GASB 74/75 OPEB Accounting ChangesGASB 74/75 OPEB Accounting Changes
GASB 74/75 OPEB Accounting ChangesJim van Iwaarden
161 views1 slide
GASB 74/75 - Preparing for the New World of OPEB Accounting by
GASB 74/75 - Preparing for the New World of OPEB AccountingGASB 74/75 - Preparing for the New World of OPEB Accounting
GASB 74/75 - Preparing for the New World of OPEB AccountingJim van Iwaarden
167 views30 slides
Lessons from the Front Lines of GASB 75 Reporting by
Lessons from the Front Lines of GASB 75 ReportingLessons from the Front Lines of GASB 75 Reporting
Lessons from the Front Lines of GASB 75 ReportingJim van Iwaarden
148 views25 slides

More from Jim van Iwaarden(13)

Pension & OPEB Funding Strategies for Illinois Public Plans by Jim van Iwaarden
Pension & OPEB Funding Strategies for Illinois Public PlansPension & OPEB Funding Strategies for Illinois Public Plans
Pension & OPEB Funding Strategies for Illinois Public Plans
Jim van Iwaarden172 views
The Alphabet Forest: OPEB, GASB and Pensions by Jim van Iwaarden
The Alphabet Forest: OPEB, GASB and PensionsThe Alphabet Forest: OPEB, GASB and Pensions
The Alphabet Forest: OPEB, GASB and Pensions
Jim van Iwaarden122 views
GASB 74/75 - Preparing for the New World of OPEB Accounting by Jim van Iwaarden
GASB 74/75 - Preparing for the New World of OPEB AccountingGASB 74/75 - Preparing for the New World of OPEB Accounting
GASB 74/75 - Preparing for the New World of OPEB Accounting
Jim van Iwaarden167 views
Lessons from the Front Lines of GASB 75 Reporting by Jim van Iwaarden
Lessons from the Front Lines of GASB 75 ReportingLessons from the Front Lines of GASB 75 Reporting
Lessons from the Front Lines of GASB 75 Reporting
Jim van Iwaarden148 views
Opeb investments the danger in playing it safe by Jim van Iwaarden
Opeb investments the danger in playing it safeOpeb investments the danger in playing it safe
Opeb investments the danger in playing it safe
Jim van Iwaarden755 views

Recently uploaded

OAT_RI_Ep14 WeighingTheRisks_Nov23_GeopoliticalConcerns.pptx by
OAT_RI_Ep14 WeighingTheRisks_Nov23_GeopoliticalConcerns.pptxOAT_RI_Ep14 WeighingTheRisks_Nov23_GeopoliticalConcerns.pptx
OAT_RI_Ep14 WeighingTheRisks_Nov23_GeopoliticalConcerns.pptxhiddenlevers
15 views4 slides
Tax year 2024 Advance Taxation book by Khalid Petiwala by
Tax year 2024 Advance Taxation book by Khalid PetiwalaTax year 2024 Advance Taxation book by Khalid Petiwala
Tax year 2024 Advance Taxation book by Khalid PetiwalaSazzad Hossain, ITP, MBA, CSCA™
15 views477 slides
Jeremy Hunt's letter to Nausicaa Delfas by
Jeremy Hunt's letter to Nausicaa DelfasJeremy Hunt's letter to Nausicaa Delfas
Jeremy Hunt's letter to Nausicaa DelfasHenry Tapper
518 views2 slides
supplyfied .pdf by
 supplyfied .pdf supplyfied .pdf
supplyfied .pdfValueBusiness
21 views11 slides
Pandit No2 Black Magic Specialist In Lahore Black magic In Pakistan Kala Ilam... by
Pandit No2 Black Magic Specialist In Lahore Black magic In Pakistan Kala Ilam...Pandit No2 Black Magic Specialist In Lahore Black magic In Pakistan Kala Ilam...
Pandit No2 Black Magic Specialist In Lahore Black magic In Pakistan Kala Ilam...Amil baba
6 views1 slide
1_updated_Axis India Manufacturing Fund-NFO One pager.pdf by
1_updated_Axis India Manufacturing Fund-NFO One pager.pdf1_updated_Axis India Manufacturing Fund-NFO One pager.pdf
1_updated_Axis India Manufacturing Fund-NFO One pager.pdfmultigainfinancial
14 views3 slides

Recently uploaded(20)

OAT_RI_Ep14 WeighingTheRisks_Nov23_GeopoliticalConcerns.pptx by hiddenlevers
OAT_RI_Ep14 WeighingTheRisks_Nov23_GeopoliticalConcerns.pptxOAT_RI_Ep14 WeighingTheRisks_Nov23_GeopoliticalConcerns.pptx
OAT_RI_Ep14 WeighingTheRisks_Nov23_GeopoliticalConcerns.pptx
hiddenlevers15 views
Jeremy Hunt's letter to Nausicaa Delfas by Henry Tapper
Jeremy Hunt's letter to Nausicaa DelfasJeremy Hunt's letter to Nausicaa Delfas
Jeremy Hunt's letter to Nausicaa Delfas
Henry Tapper518 views
Pandit No2 Black Magic Specialist In Lahore Black magic In Pakistan Kala Ilam... by Amil baba
Pandit No2 Black Magic Specialist In Lahore Black magic In Pakistan Kala Ilam...Pandit No2 Black Magic Specialist In Lahore Black magic In Pakistan Kala Ilam...
Pandit No2 Black Magic Specialist In Lahore Black magic In Pakistan Kala Ilam...
Amil baba6 views
1_updated_Axis India Manufacturing Fund-NFO One pager.pdf by multigainfinancial
1_updated_Axis India Manufacturing Fund-NFO One pager.pdf1_updated_Axis India Manufacturing Fund-NFO One pager.pdf
1_updated_Axis India Manufacturing Fund-NFO One pager.pdf
Stock Market Brief Deck 1129.pdf by Michael Silva
Stock Market Brief Deck 1129.pdfStock Market Brief Deck 1129.pdf
Stock Market Brief Deck 1129.pdf
Michael Silva53 views
score 10000.pdf by sadimd007
score 10000.pdfscore 10000.pdf
score 10000.pdf
sadimd0079 views
Indias Sparkling Future : Lab-Grown Diamonds in Focus by anujadeodhar4
Indias Sparkling Future : Lab-Grown Diamonds in FocusIndias Sparkling Future : Lab-Grown Diamonds in Focus
Indias Sparkling Future : Lab-Grown Diamonds in Focus
anujadeodhar47 views
Stock Market Brief Deck 121.pdf by Michael Silva
Stock Market Brief Deck 121.pdfStock Market Brief Deck 121.pdf
Stock Market Brief Deck 121.pdf
Michael Silva21 views
The breath of the investment grade and the unpredictability of inflation - Eu... by Antonis Zairis
The breath of the investment grade and the unpredictability of inflation - Eu...The breath of the investment grade and the unpredictability of inflation - Eu...
The breath of the investment grade and the unpredictability of inflation - Eu...
Antonis Zairis7 views
QNBFS Daily Market Report November 29, 2023 by QNB Group
QNBFS Daily Market Report November 29, 2023QNBFS Daily Market Report November 29, 2023
QNBFS Daily Market Report November 29, 2023
QNB Group9 views
Teaching Third Generation Islamic Economics by Asad Zaman
Teaching Third Generation Islamic EconomicsTeaching Third Generation Islamic Economics
Teaching Third Generation Islamic Economics
Asad Zaman89 views
Debt Watch | ICICI Prudential Mutual Fund by iciciprumf
Debt Watch | ICICI Prudential Mutual FundDebt Watch | ICICI Prudential Mutual Fund
Debt Watch | ICICI Prudential Mutual Fund
iciciprumf6 views
What is Credit Default Swaps by MksSkyView
What is Credit Default SwapsWhat is Credit Default Swaps
What is Credit Default Swaps
MksSkyView8 views

Cross tested plans - how-to & examples

  • 1. Cross-Tested Plans James A . van I waarden, F S A , E A Con s u l t i ng A c t u a r y Van I wa a rde n A s s o c i a tes Minneapo l is, MN ISCEBS Sympo s ium, B o s ton Sep tember 2 5 , 2 013
  • 2. Today’s Menu y What are cross-tested plans? y History y Cross-testing “recipe” y Plan designs y Other uses y What works, what to avoid y How to use cross-tested plans with 401(k)’s
  • 3. What are Cross-Tested Plans? y Plans that don’t fit into IRS pre-approved designs y Or...a group of non-identical plans y Show nondiscrimination by converting contributions into benefits (cross) and testing the benefits (testing!)
  • 4. History of Cross-Testing – Part I §401(a)(4) •...benefits or contributions do not discriminate in favor of HCEs... RR 81- 202 •comparability of plans 410(b) & 401(a)(4) regs •200+ pages, early 1990’s
  • 5. History of Cross-Testing – Part II New Comparability •a.k.a. class allocation plans, based on the new regulations Threats to outlaw • led to “gateways” effective 2002 Stable for 10+ years •now, even prototype plans include class allocation option
  • 6. Cross-Testing “Recipe” for DC Plans Step 1: pass thru any of three “gateways” Go! Broadly available allocation rates Gradual age or service schedule Minimum alloc rate: 5% or 1/3 top HCE
  • 7. Cross-Testing “Recipe” for DC Plans y Step 2: prepare the ingredients @ 8½% interest Contribution for each ee To age 65 ÷ annuity factor (we’ll use 10) to get annual benefit ÷ pay = accrual rate
  • 8. Cross-Testing “Recipe” for DC Plans y Step 3: mix it all together There’s a rate group for each HCE; it includes the HCE & everyone (HCE or NHCE) with a higher accrual rate: ees w/ rate >=HCE#1 HCE#1 Test each rate group to see if it passes the §410(b) coverage test: • 70% ratio percentage test, or • average benefit percentage test Ratio % below is 75% ÷ 50% = 150% %/HCEs 2/4=50% %/NHCEs 3/4=75%
  • 9. Cross-Tested Plan Designs y Common designs include: { Age-weighted: guaranteed to pass { Service-weighted { Class allocation (aka “new comparability”) { DB/DC, usually cash balance & profit sharing { Examples for Dr. F & his faithful servants...
  • 10. Cross-Tested Plan Designs y Age-weighted profit sharing plan { Always passes §401(a)(4) test, but not very flexible { Gateway is gradual age or service schedule { One rate group covers HCE (Dr. F) & both NHCEs, ratio % = 100% Age Service Pay PS % PS $ Benefit Accrual Rate Dr. Frankenstein 60 40 $255,000 20% $51,000 3.01% Igor 40 10 50,000 3.91% 1,955 3.01% Inga 30 5 30,000 3%* 900 5.22% * Age-weighted formula produces 1.73%, but 3% top-heavy minimum applies.
  • 11. Cross-Tested Plan Designs y Service-weighted profit sharing plan { Rewards loyalty, not very common { PS in this example is ½% of pay per year of service { Gateway is gradual age or service schedule { One rate group covers HCE (Dr. F) & both NHCEs, ratio % = 100% Age Service Pay PS % PS $ Benefit Accrual Rate Dr. Frankenstein 60 40 $255,000 20% $51,000 3.01% Igor 40 10 50,000 5% 2,500 3.85% Inga 30 5 30,000 3%* 900 5.22% * Service-weighted formula produces 2.5%, but 3% top-heavy minimum applies.
  • 12. Cross-Tested Plan Designs y Class allocation (aka “new comparability”) profit sharing { Very common, even prototype documents include this option { Gateway is minimum allocation 5% or 1/3 of highest HCE rate { One rate group covers HCE (Dr. F) & both NHCEs, ratio % = 100% Age Service Pay PS % PS $ Benefit Accrual Rate Dr. Frankenstein 60 40 $255,000 20% $51,000 3.01% Igor 40 10 50,000 5% 2,500 3.85% Inga 30 5 30,000 5% 1,500 8.69%
  • 13. Cross-Tested Plan Designs y DB/DC combo: cash balance & profit sharing { Common for professional firms { Enables large deductible contributions for owners { Gateway here is 7½% DC; Igor & Inga get 3% cash balance credits { This example is for a PBGC-covered plan, Frankenstein Mfg. Inc. Ù A PBGC-exempt professional firm may need to limit DC er contrs to 6% Age Pay Cash Balance Credit PS & 3% Safe Harbor 401(k) & Catchup Total Dr. F’stein 60 $255,000 $230,000 $33,500 $23,000 $286,500 Igor 40 50,000 1,500 3,750 whatever 5,250+401k Inga 30 30,000 900 2,250 whatever 3,150+401k
  • 14. Other Uses for Cross-Testing y Can structure retirement plans by business unit y Could be all DB, all DC or a combination y It’s a lifesaver for mergers & acquisitions
  • 15. Other Uses for Cross-Testing y Case study: parent & acquisitions, 25,000 total ees DB/DC DB only DC only y Combine all the plans and test on a benefits basis y Can apply this for any group of non-identical plans
  • 16. Cross-Testing – What Works, What to Avoid y What works great { Profit sharing / cash balance combination Ù PS projected at 8½% interest Ù Cash balance at interest crediting rate (usually much lower) Ù Better results than pure DB or pure DC Ù Effect is known as
  • 17. Cross-Testing – What Works, What to Avoid y What works great { 401(k) 3% safe harbor { You get a triple dip Ù Free pass for ADP & ACP tests Ù Covers DC top-heavy requirement Ù Counts for cross-testing base & gateway { A few issues Ù Notice required >30 days before plan year starts Ù 100% vesting Ù Can’t impute “permitted disparity” (FICA recognition) for testing { Add profit sharing, if needed to meet gateway
  • 18. Cross-Testing – What Works, What to Avoid y What to avoid { Unfavorable demographics Ù HCEs younger than others Ù Usually a solution, but it’s tricky { Inflexible plan designs Ù Contribution rates specified in plan document Ù Even prototypes now allow each participant in own class
  • 19. Cross-Testing – What Works, What to Avoid y What to avoid { Failing the §401(a)(4) test! { Causes Ù Demographic changes, especially new young HCEs Ù Inflexible plan designs { Prevention Ù Test before contributing Ù Flexible plan designs { Cure Ù §1.401(a)(4)-11(g) corrective amendment Ù Can provide extra contributions for a targeted group of NHCEs Ù Must be done within 9½ months after end of year
  • 20. Cross-Testing – What Works, What to Avoid y What to avoid { 401(k) matching contributions (even safe harbor) { Really? { Deferrals & match don’t count for 1st stage of §401(a)(4) test { You can still match, but it’s an extra expense { What can you do? Ù Convert match to 3% safe harbor, with advance notice Ù Add profit sharing for gateway & cross-testing base
  • 21. Using Cross-Tested Plans with 401(k)’s y Get top people within deferral range of §415 DC maximum { In 2013, that’s $51,000 - $17,500 = $33,500 (13.14% of max pay) y Cover the gateway for NHCEs { If HCEs are at 13.14%, NHCEs need to be at 1/3 of that: 4.38% y Use 3% non-matching safe harbor { That leaves only 1.38% needed for NHCE profit sharing { Frees HCEs to maximize 401(k) deferrals y Still need to run the test { But gateway is often enough to pass 20% 15% 10% 5% 0% NHCE HCE Def PS SH
  • 22. Take-Out Menu y Cross-testing is the most powerful testing tool there is! y You can structure plans to fit business needs y It makes some amazing plan designs possible