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justanotheradmin

Cross-testing with a 401(k)

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What are the pit falls of cross-testing a cash balance plan on a contribution / allocation rate basis? 

Is this not allowed?

Fact Pattern  - bear with me

Small law firm has two partners, two employees (NHCE). 

There is an existing 401(k) plan with a 3% Safe Harbor non-elective (will be amended to NHCE only for 2020). 

The earned income for the partners fluctuates a lot due to when they receive settlements from cases. In years where they have a lot, it would be super helpful to be able to make large contributions to the plans. I was thinking a contribution credit formula that increased the higher the compensation. Something like 100% of compensation in excess of $100,000, or $5,000, whichever is greater.

They are not opposed to doing large contributions for their NHCE. If they can be done into the 401(k) as SH and PS, that would be ideal, then they aren't committing to large contribution credits to the NHCE in the CB plan. 

Because of the ages of the partners and the NHCE, regular combined testing doesn't work well. Its okay, but one of the partners is on the younger side, and the main NHCE is older than both partners by 10+ years. The NHCE would get 2.5% contribution credit in the CB. 

I apologize, I am not an actuary and don't do a lot of work on DB plans. 

But I do plenty of rate group testing, 401(a)(4) etc in the DC world. So if I am testing the combined benefits can't I just take the (Safe Harbor + Profit Sharing + Cash Balance contribution credit) / Compensation = Rate

Then do my regular HCE NHCE rate group testing? 

One of our actuaries is thinking we would need to convert the contribution credit to the NRA annuity benefit, then convert back to present value, then use that amount combined with the SH and PS for testing. I understand his argument, but would prefer my simpler method if possible. 

The actuary is proposing just giving the NHCE a flat % of pay in the CB and avoiding this type of combined testing. But it would be much more flexible if we could customize the NHCE benefit each year since the partner's compensation changes can be quite extreme. It will be easier to do this after year end with a discretionary profit sharing contribution to the NHCE, than trying to amend the CB plan prospectively to adjust an NHCE benefit. 

Some things I've already thought about - but feel free to chime in:

415: The younger partner's CB benefit is limit because of his age

404: There should be plenty of $ available to give as profit sharing and safe harbor to the NHCE and still stay within the 6% deduction limit

I apologize if I am off my rocker - I was just thinking if I can cross-test a 401(k) plan on a benefits basis, why can't I cross test the other way, a DB plan on an allocation basis? 

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Yes, you can test a DB plan on a contribution rate basis by using the present value of the increase in the accrued benefit.

15 hours ago, justanotheradmin said:

But I do plenty of rate group testing, 401(a)(4) etc in the DC world. So if I am testing the combined benefits can't I just take the (Safe Harbor + Profit Sharing + Cash Balance contribution credit) / Compensation = Rate

This however you can't do. Your actuary is correct. A CB pay credit is a hypothetical allocation.

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If you have it, the Cash Balance Answer Book shows exactly how to convert the contribution credit/accrued benefit to an equivalent contribution. You may be able to restructure and pair old NHCE with young partner, testing on contribution basis, and older partner with younger NHCE on a benefits basis. 

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Thank you C.B. Zeller and CuseFan! 

Good to know it's possible, (though not as simple as I'd like), and as I suspected the actuary is correct. I don't have a copy of the Cash Balance Answer Book, but one of our actuaries might, so I will definitely look into it. 

And yes CuseFan, I've thought about splitting the participants up and doing component testing as you suggest. Now that I know more about testing a DB plan on a contribution basis, I'll have our actuaries give it a whirl!

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