A new comparability profit sharing allocation formula in a qualified retirement Plan allows a Plan Sponsor to target certain classes or groups of employees, or even individuals, with a higher percentage of annual employer profit sharing contributions. Typically, groups are identified based on their job title or position within the company (examples: Owners, Officers, Managers, Supervisors, Foreman, Administrative, etc.). The contribution amount is typically discretionary and determined on an annual basis.
The employer contribution is allocated by a formula which requires “Cross-Testing” as established in the plan document. The result is that you can give each group a different percentage allocation of pay, providing that a complex set of non- discrimination testing passes. The testing results largely depend on the targeted group or person’s age (years remaining to retirement) along with who is identified as a Highly Compensated Employee (HCE). HCE’s are generally defined as greater than 5% owners, lineal family members or spouse of 5% owner, or anyone earning greater than the indexed limit. An employee must earn more than the indexed limit in the prior year to be considered highly compensated. Basically, this type of profit sharing allocation formula works very well if you are targeting an older, higher paid group of employees that are instrumental to the overall success of your company.
The major challenge in designing an effective plan with a new comparability formula is that the allocations are very demographic dependent; results can vary from year to year and from company to company. Without looking at historical census data, it is hard to say whether there are enough NHCEs that are the right ages to pass the required IRS discrimination tests on an annual basis. Please note that NHCEs (non- highly compensated employees) must receive the IRS mandated minimum gateway allocation of either:
Some of the benefits of making a profit sharing contribution are as follows:
The Paragon Alliance Group specializes in customized plan design and will assist you in the implementation and ongoing administration of this potentially valuable plan design feature. Please click the link below for a SAMPLE comparison of employer costs utilizing different profit sharing allocation formulas: