The 'Gateway' to Retirement Plan Flexibility
Owners of small businesses and professional practices can achieve greater flexibility in how they apportion contributions to employees when they participate in a profit-sharing retirement savings plan by employing a “cross-tested” design known as New Comparability.
New Comparability plans make use of what is known as a “gateway,” enabling business owners to earmark company contributions to groups or tiers of employees based on criteria such as salary or age. These plans allow business owners and other highly compensated employees to receive larger contributions than permitted under traditional retirement plans by ensuring that every plan participant receives a minimum contribution of 5 percent of salary or one-third of the contribution rate made on behalf of the highest compensated employee, whichever is less.
For example, if the small-business owner is making $200,000 annually and contributed 20 percent of salary or $40,000 to the plan on her own behalf, a non-highly compensated employee earning $50,000 annually would have to receive the lesser of 5 percent of salary or one-third of the contribution rate made on behalf of the owner’s contribution, whichever is less. That means the employee would receive at a minimum a contribution to his retirement plan of $2,500 or 5 percent of salary (as opposed to $3,335, which is one-third of the contribution made on behalf of the owner). The employer’s contribution would be considered the gateway to allowing different contributions on behalf of other tiers of employees.
The gateway allows the employer to divide employees into different groups or tiers – typically highly compensated and non-highly compensated -- with separate contribution amounts and separate discrimination testing for each.
New Comparability plans tend to favor older, more highly compensated employees who are placed in a separate tier. But the inclusion of the gateway ensures that all employees receive a meaningful contribution or benefit, which then allows greater flexibility in how the IRS applies nondiscrimination testing.
Of course, any consideration of different retirement plan designs such as New Comparability should generally start with a careful review and include consultation with plan legal counsel and other experienced advisors, as appropriate. Whether a New Comparability plan design is appropriate hinges on the business owner’s individual and company retirement plan goals.
Not all owners of business or professional practices can afford to implement a gateway in a retirement plan. But for those who can and embrace the concept, a world a greater flexibility – not to mention bigger retirement contributions -- awaits.
E. Thomas Foster Jr. is Assistant Vice President, Strategy and Relationships, for MassMutual Retirement Services, a division of Massachusetts Mutual Life Insurance Co.
This article is for informational purposes only and should not be construed as legal, investment, and/or tax advice. Please consult your own legal counsel and other experts regarding the specific application of the information set forth herein to your own plan and/or circumstances.