Cross Tested Profit Sharing Plan Scenario

[Guest MCarey1]

We have a client who is proposing the following new 401(k) profit sharing plan scenario:

No Match, but employer Contributions as follows:

Staff & Admin ee's - 3%

Sen. Personnel w/5 years service - 3 1/2%

Managers - 4 1/2%

Non Shareholders - 5%

Class I Shareholders - 6 1/2%

Class II Shareholders - 9%

Note: The Class II equity shareholders would include a vol. contribution of 2 1/2%. The e way they ahve developed this plan is that the firm would pay up to 6 1/2% for the Class I shareholders and if a Class I wanted to move to a Class II, they could voluntarily have 2 1/2% contributed from their annual bonus amount instead of receiving it in cash (these additional monies would be in excess of the employees deferral).

Has anyone ever heard of anything like this and if so how does this pass testing.

Also, will the addtional contribution in lieu of bonus count toward deferrals.

I guess my big

[Fred Payne]

I think you run into problems when "voluntary" contributions in lieu of cash wages are construed as Employer nonelective contributions. Voluntary deferrals are what they are: salary defrrals that must count towards the ADP.

Why not set up a Safe harbor 401(k) that uses the 3% nonelective contirbution? Your groups appear OK to me except Class I and Class II shareholders. Allocation Groups must be readily identifiable and I don't think that means a participant falls into one or the other based on a "voluntary" contribution.

You can have different classes of shareholders that might get 6 1/2% vs 9%.

The allocation rates you are suggesting ranging from 3% to 9% would pass the Gateway test.

[MBCarey]

Fred,

Thanks for your answer. My thoughts agree with yours, but my trustee seems to think that since the additional contribution would be put into the shareholders account as a profit sharing contribution rather than a "deferral" would not come under the ADP? I disagree and I think from what you said so do you.

[Fred Payne]

With a 401(k) Safe Harbor Cross-tested design, I have found the best strategy is to give the 3% non-elective vs the Basic Match. The Basic Match and a discretionary contribution are not included in the Ratio Percentage Test, and that's a negative in my opinion. The 3% non-elective allows the HCEs to max their salary deferals and it is included in the Ratio Percentage Test (although you cannot impute disparity on the 3% nonelective.)

The 3% also counts toward the Gateway. Thus, the HCEs could get as high as a 9% contribution. The six percentage points of contribution over and above the 3% non-elective is not considered salary deferral and is not part of any ADP calulation.

These contributions may fail the Ratio Percentage Test, in which case the Average Benefits Test comes into play. To passs the ABT, each Rate Group must first pass the Nondiscrimintion Class Test.

If there is a testing failure, then either the NCEs must get less that 9% or the NHCs get more than 3%. Often times it is just one HCE that causes the failure. We try to carve out a separate group for the culprit to give him a lower contribution while the balance of the HCEs get the full 9%.

If the Plan Sponsor wants only a 401(k) Safe Harbor 401(K), we like to determine if the addition of a crosstested PS might not just get the HCEs up to 6 extra percentage points of contribution.