Practice Management

Overcoming the Tyranny of Equality

By Tom Foster

When it comes to retirement savings, one size does not fit all.

Retirement savings needs can vary drastically from person to person, especially when it comes to differences in age, income, lifestyle and goals. That’s why a profit-sharing defined contribution retirement plan can be designed to accommodate such factors.

Many of the business owners and professionals that I speak with assume that all contributions to a profit-sharing plan must be equal – known as a pro-rata allocation — with each employee receiving the same percentage of salary. But spreading contributions equally can mean that the owner no longer can afford to contribute enough to the plan to continue his or her own lifestyle in retirement.

It’s the tyranny of equality.

Advisors can help their clients who own businesses overcome this obstacle by suggesting they consider an advanced retirement plan design technique known as “cross testing.” A cross-tested plan allows a company to place each eligible retirement plan participant into his or her own “tier” and then determine, on an annual basis, how much the business contributes to the plan on behalf of each individual or groups of individuals. The tiers can be based on factors such age, compensation or replacement of pre-retirement income by Social Security.

The bottom line: many owners and professionals find that cross-testing enables them to accumulate more retirement savings providing they also contribute a minimum or “meaningful” benefit on behalf of each employee. Internal Revenue Code rules prescribe what constitutes a “meaningful benefit” based on how the tiers are defined as well as other factors.

Of course, any consideration of different retirement plan designs should generally start with a careful review and include consultation with plan legal counsel and other experienced advisors, as appropriate. Engaging a local third party administrator can also be helpful.

You can read more about the different types of cross-testing designs in upcoming blogs. Meanwhile, contact your retirement plan provider to learn more about how cross-testing can help business owners and professionals save more for retirement.

  1. 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.