Cross-Tested Retirement Plans

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    What is a cross-tested plan?

    “Cross-testing” is a term used by the IRS to describe a retirement plan (usually a profit-sharing plan) that has different contribution percentages for different groups of employees. For example, the business owners may want to contribute 25 percent of compensation for themselves but only 5 percent of compensation for each of the other employees.

    Retirement plans cannot discriminate against non-highly compensated employees; therefore, plans must prove nondiscrimination by testing benefits across the various groups. This can sometimes allow the business owners (or favored employee groups) to have larger contributions than the rest of the employees.

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    What are the benefits of a cross-tested plan?

    One of the benefits of cross-tested plan is that, if the company owner is older than the average age of the other employees, he or she can often contribute at a higher rate. With fewer years to accumulate, his or her individual contribution must be higher than the other employees in order to get the same level of benefits at retirement age. In some cases, a cross-tested plan can be created even if the average employee age is higher than the business owner.

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    Who may establish a cross-tested plan?

    Any employer is eligible to establish a cross-tested plan.

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    Who may participate in a cross-tested plan?

    Both employers and employees may participate in this plan.

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    How is a cross-tested plan established?

    1. Adopt a written plan, called the plan document, which outlines its day-to-day operations.
    2. Identify a plan provider and/or trust for the plan’s assets and investments.
    3. Select a recordkeeper or recordkeeping system to track contributions, earnings and losses, and distributions. This person or entity will also help prepare the annual return, which must be filed with the federal government.
    4. Select a third party administrator to maintain the retirement plan document, fulfill daily tasks and ensure compliance with federal regulations. Your financial advisor may choose a third-party administrator and/or recordkeeper on your behalf.
    5. Provide eligible employees, or plan participants, with a summary plan document (SPD), which is the document that outlines who can participate and how the plan works.

    The written plan also provides a central document, or collection of documents, which explains the rights of the employees and employee eligibility for participating in the plan and enables government agencies to determine whether it satisfies applicable laws.

    If the plan allocates responsibilities for performing administrative functions to other parties, such allocation must identify who is responsible for ensuring compliance with the requirements of the tax code, including compliance requirements for loans and distributions.

    In the case of funding through multiple financial institutions, the employer may adopt a single written plan to coordinate administration among the financial institutions, rather than having a separate document for each issuer.