Creative Plan Design Ideas
Administrative Retirement Services, Inc.(ARS) believes that plan design is paramount to the success of a retirement plan. In order to properly design a retirement plan, the plan objective must be clearly defined. The most common plan objective we encounter and the one we are going to discuss first is to maximize benefits to the business owner while minimizing contributions to the other participants. This objective can be met by setting up a Cross-Tested Safe Harbor 401(k) Plan. A Cross-Tested Safe Harbor 401(k) Plan is a type of retirement plan which provides the most flexibility in how profit sharing contributions are allocated.
Cross Tested Plans
Cross-testing is a plan design concept which allows a company to define classes of employees and contribute profit sharing contributions on a percentage basis to each class. Cross-testing works best in a company which has a business owner who is slightly older than the rest of the employees. Annually, the contribution formula must pass an average benefits test. In addition to the average benefits test, the plan must also satisfy a minimum allocation gateway where each non-highly compensated employee (NHCE) in the plan has an allocation rate that is at least one-third of the allocation rate of the highly compensated employee (HCE) with the highest allocation rate, or, each NHCE receives an allocation percentage of at least 5% of the NHCE's compensation.
In a typical cross-tested plan, HCEs receive a higher allocation rate, often 14% to 25% of compensation, while NHCEs, regardless of their age or years of service, receive comparatively lower allocation rates of 5% or less of compensation. For clients who want to utilize cross-testing and safe harbor but want to contribute the minimum amount and receive the maximum available, the owner would receive 9% of compensation and the other eligible employees would receive 3%, which passes the allocation gateway described above.
Safe Harbor 401(k) Plans
Safe Harbor is a concept which has been around since 1999 and allows plans to automatically pass nondiscrimination and top-heavy testing. A Safe Harbor 401(k) Plan requires that the plan sponsor contribute either 3% of compensation to all eligible participants, or match 100% of the first 3% plus 50% of the next 2% of employee compensation deferred. Both contributions are 100% vested immediately.
In order for a company to adopt safe harbor for a calendar year plan, the plan must be amended and notice must be given to the employees at least 30 days prior to the beginning of the plan year, or by December 1 for calendar year plans.
The maximum contribution a participant can receive in a 401(k) profit sharing plan for 2019 from all contribution sources such as 401(k), profit sharing, matching and safe harbor is $56,000, plus any catch-up contributions. See our Dollar Limits page for a complete listing of the 2019 annual plan limits.
In most plan design scenarios the company contribution is reduced if the business owners can contribute the maximum 401(k) amount. For 2019, participants can contribute $19,000 to a 401(k) plan. If the participant will attain the age of 50 during 2019, they can also contribute $6,000 as a catch-up contribution. One way to guarantee that the business owner will be able to contribute the maximum 401(k) amount without testing issues is to adopt either Safe Harbor contribution option.
If the business owner utilizes safe harbor and has a spouse on the payroll, the spouse can contribute 100% of their wages up to the annual limits to the plan.
See example here of Cross-Tested Safe Harbor 401(k) Plan and Safe Harbor Match
For specific plan design ideas, contact Administrative Retirement Services, Inc.