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Cross-Testing Plans Can Benefit Older, Highly Paid Employees

Rather than considering contributions, cross-testing focuses on benefits.

By Lee Barney editors@strategic-i.com | February 25, 2016
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Cross-testing is a technique advisers might want to consider for smaller plan sponsors with populations of older, higher-paid employees.

Cross-testing combines profit-sharing contributions with defined contribution plans—and, by projecting the benefits afforded to employees at retirement, rather than allocations made along the way—it allows some sponsors to more easily fulfill non-discrimination requirements.

“A company that already has a traditional 401(k) can overlay cross-testing on top of that,” explains Jay Well, a financial adviser with Foresight Wealth Management in Sandy, Utah. “It changes the way the 401(k) is tested for non-discrimination. In typical non-discrimination testing, the Internal Revenue Service (IRS) looks at how much money is being contributed and whether highly compensated employees (HCEs) and non-highly compensated employees (NHCEs) are benefitting equally. Cross-testing looks at the benefit of those contributions at retirement. Because younger employees have a longer time horizon to grow their assets, it effectively permits employers to contribute more for their older employees.”

Cross-testing allows the profit-sharing component to be tested as a defined benefit would be tested—what the contributions will produce as a benefit at retirement, adds Ted Sarenski, CEO and president of Blue Ocean Strategic Capital in Syracuse, New York. Essentially, cross-testing focuses on extended benefits at retirement, says Tom Foster, national spokesperson for MassMutual Retirement Services in Enfield, Connecticut.

The 2016 IRS limits for employee 401(k) contributions of $18,000 and the $6,000 catch-up for those age 50 and older still apply. However, the employer contributions are considered profit sharing and may be added on top of each employee’s 401(k) contributions up to $53,000 or 100% of compensation, whichever is less, Foster says.

NEXT: When cross-testing makes sense