Cross-tested plans and longevity?

[Shubha]

Feel free to point me to a different group if this isn't the right place for this...

 

I work for an organization where we implemented a policy to increase the employer contribution to people's 401K the longer they are at the org.  We're trying to change our 401K to our PEO's 401K, and they said they can't implement this policy BUT they can do "a cross-tested PS formula.  This wouldn’t exactly be a tiered option based on years of service, and the gateway minimums for a cross-tested PS formula would still apply.  This is the closest option available."

I have no idea what this means, or how I can use it for longevity.  All my googling implies that cross-tested plans *may* have to do with people's ages, but also may not??  I can't find a simple definition of what this is, and how one can use it (and can I use it for our longevity policy)?

 

[Bri]

This is the right place.

A cross-tested PS formula means that there will be different contribution rates to different employees.  (Thinking, the IRS typically would expect a plan to provide some uniformity to the contributions.)  But if the contributions can be projected to retirement age, perhaps the eventual benefits from those contributions will be closer to equivalent.  Especially if the people getting more are so close to retirement age that there's not much of a projection, relative to a 30-year-old who could start with a lot less but let the time do the work of growing to a comparable benefit.  Anyway, that's the "cross" to the definition - instead of testing contributions, we're crossing it up and instead testing the eventual benefits.

Okay, so now the IRS came up with "gateway" rules to try to put the kibosh on just hiring 16-year-olds, giving them $100, and saying hey 50 years of time should even things up compared to the company owner who's 65 and wants $69,000 in profit sharing *currently*.

Basically the gateway rules force a guaranteed floor on how low the $100 to the youthful staff can be, and it's typically a percentage of pay that depends on what sort of amounts the highly compensated employees are getting from the company.

Not all plans like this, where the plan does not provide a uniform rate to all employees, are subject to gateway rules, but most are.  The ones that aren't could potentially include your hoped-for design.  There are regulations which spell out what kind of designs may get away with this.  Typically they involve bands by age, so that all employees have the chance to "age into" the higher rates. 

A common approach is to age-weight the contributions so that every single age ends up with an equivalent benefit rate at retirement age. (Basically each person the same age gets the same rate, and that rate goes up by an identical 8.5% a year as you age.)  If you do get a plan that fits the exceptions, then it's okay if certain individuals' contribution rates are smaller than what these "gateway" rules would require.

Anyway, I suspect your PEO wants no part of making sure your subset's allocations can fit into such a design, so they're telling you just to go with the more-common approach where you do guarantee a gateway floor rate to the staff employees.

 

[LANDO]

Sounds like what you want/have is a service based contribution, i.e. the employer contribution level is tied to the number of years the participant has worked for your company.

This type of allocation can be achieved with a "cross-tested allocation formula" using a participant by participant allocation formula, which allows you to contribute a different rate to each participant. Someone, perhaps your company, would need to tell the PEO administrator how much you wish to contribute for each participant...based on your old formula.  Then those allocations would be subject to special non-discrimination testing and the minimum gateway requirements mentioned above.  Generally, the minimum gateway is the lesser of 1/3rd the highest allocation rate received by any HCE or 5%. Depending on whether your plan has allocation conditions (last day and/or 1000 hours requirements to get the employer contribution) and what the lowest and highest allocation rates are, this may work for you.

The only way to know if this might work for your situation is to have someone run some sample illustrations/testing for you.

 

 

[John Feldt ERPA CPC QPA]

If you have the right ratios of HCEs and NHCEs at each rate or above, test it on a contributions-basis to avoid the gateway. Maybe you’ll pass. If you have each person in their own allocation rate group and a rate fails, just find more NHCEs for that rate or tell the HCEs that they will receive a lower allocation rate that will pass.