Allowable Discrimination

[richard]

A privately held corporation will be setting up a profit sharing plan. Somewhere between 10% and 50% of the Plan assets will be invested in the stock of the corporation.

Can the Plan meet nondiscrimination rules using cross testing? For example, can the Plan use an age-weighted allocation in its allocation formula?

[MWeddell]

The answer to your question depends on whether the plan or a portion of it is designated as an ESOP. The ESOP portion of the plan may not be tested on an age-weighted basis.

You could not designate it as an ESOP. ERISA 404 makes clear that a profit-sharing plan also may provide that > 10% of plan assets be invested in employer securities, although most observers feel that there's more fiduciary risk with a profit sharing plan doing this instead of an ESOP.

Another option would be to age-weight for testing purposes only the portion not invested in company stock and to designate the portion invested in company stock as an ESOP.

Lastly, these rules apply to how the testing is done. You can age-weight or do whatever you want to the allocation formula as long as the plan has a definite allocation formula, the annual contributions meet the 401(a)(4) discrimination test, and contributions can't decrease with age without violating age discrimination prohibitions.

[Guest Larry Goldberg]

A profit sharing plan can meet Section 401(a)(4) non-discrimination by cross-testing. An ESOP is prohibited from using cross-testing. A profit sharing plan can invest some or all of its assets in employer securities (so long as it meets the the requirements of Section 407 of ERISA). A profit sharing plan will not become an ESOP simply by investing all or any portion of its assets in employer securities. Therefore, a profit sharing plan remains eligible to use cross-testing, regardless of whether all or any portion of its assets are invested in employer securities. See Treas. Reg. Sec. 1.401(a)(4)-8(B)(1).

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