Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
What is it?
• a defined contribution plan allocation that allows
higher plan contributions for older plan entrants
• the formula for annual employer contributions or
allocations to participant accounts is based on AGE
as well as compensation level
-
older plan entrant’s accounts build up quickly
-
tends to favor owners and key-employees
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Plan Types
cross tested (new comparability plan)
– maximizes benefits to highly compensated employees
(HCEs)
– benefits to non-HCEs are whatever is necessary to meet
nondiscrimination regulations
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Plan Types
age-weighted profit sharing plan
allocation formula contains actuarial age-weighting factor that
gives a higher allocation for older plan entrants
target plan
pension plan with an age-weighted formula but requires annual
contributions
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
When is it indicated?
1. relatively older business owners and key employees
want to
– maximize own plan benefits
– minimize plan costs
2. employer wants to bring older employees into a
defined contribution plan
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
When is it indicated?
3.
want plan that provides adequate retirement
benefits to older employees with lower cost and
simplicity of a defined contribution plan
4.
when employer terminates existing defined benefit
plan and wants to provide approximately the same
benefits to most employees
5.
closely held business or professional corporation
has older key employees
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Advantages
1. can maximize retirement benefits for employees
entering plan at older ages
2. older business owners and key employees may
receive a larger portion of plan allocations as
compared with other defined contribution plans
3. provides tax-deferred savings for employees
4. simple and inexpensive to design, administer, and
explain to employees
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Advantages
5. plan benefits may be eligible for special 10 year
averaging for income tax purposes
6. individual accounts allow plan participants to benefit
from good investment results
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Disadvantages
1.
annual additions to employee account limited to
lesser of 100% compensation or $49,000 (2009);
these limits may disadvantage highly compensated
or older employees
2.
employees bear investment risk
3.
contributions to age-weighted or cross-tested profit
sharing plan must be “substantial and recurring”;
target benefit plan contributions must meet
minimum funding standards each year
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Disadvantages
4.
age-weighted profit sharing plans have uncertain
benefits; annual contributions not required
5.
target pension plan or cross-tested plan may
require annual actuarial services
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Cross-Tested Plan Design
• designed to meet nondiscrimination requirements of
IRS Code Section 401(a)(4) on the basis of benefits
provided (i.e. is tested as if were defined benefit
plan, hence ‘cross-tested’)
• cross-testing rules are complex - basically
– highly compensated can receive maximum contribution
allowed under Section 415 limits
– remaining employees given allocation that meets
requirements of cross-testing regulations
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Cross-Tested Plan Design
• in general, cross-testing regulations focus on plan’s
ultimate benefits to evaluate nondiscrimination
• plan must satisfy “gateway” requirement; small
businesses usually face minimum allocation of 5% of
compensation for nonhighly compensated
employees to meet this requirement
• when more than one highly compensated employee
is in group, plan must be broken into “rate groups” to
test for nondiscrimination
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Disadvantages of Cross-Tested Plans
• unstable plan design; age of new hires can
necessitate new plan
• plan becomes costly or impractical if have
– relatively large number of older rank and file employees
– relatively young highly compensated employees
• must analyze plan design when have new hires,
increasing plan costs
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Disadvantages of Cross-Tested Plans
• plan design inhibits hire of older employees
– can put employer in danger of violating age discrimination
legislation
– can deprive company of valuable and experienced
employees who have critical skills
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Fixed-Formula Age-Weighted Plans
Age-Weighted Profit Sharing Plan
•
actuarial formula for allocating employer contributions
– allows plan to automatically pass cross-testing requirements
– reduces plan complexity and cost
•
plan is difficult to communicate to employees; younger
employees may deem larger contributions to older employees
as unfair
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Fixed-Formula Age-Weighted Plans
Age-Weighted Pension (Target Benefit) Plan
• similar to profit share plan with fixed formula, but as
pension plan must meet annual minimum funding
requirements
• disadvantages
– no guarantee of fund balance at retirement
– difficult to communicate to employees
– employers must fund annually
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Tax Implications
1. employer plan contributions tax deductible
2. employee contribution tax deferred
3. annual additions limited to 100% compensation or
$49,000 (2009)
4. must follow rules for qualified plan distributions;
premature distributions subject to penalty
5. special 10 year averaging may be available for some
lump-sum distributions
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Tax Implications
6. target pension plan is subject to minimum funding
rules of IRC Section 412
7. some employers may qualify for $500 business tax
credit for ‘qualified start up costs’
8. plan may allow employees to contribute to ‘deemed
IRA’ under plan; such contributions will limit other IRA
contributions
9. plan subject to ERISA reporting and disclosure rules
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Alternatives
defined benefit plans
– more benefit security
– greater tax deductible employer contributions for older,
highly compensated employees
– more complex and costly to design and administer
money purchase plan
– similar to target benefit plan
– without age-related contribution feature
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Alternatives
nonqualified deferred compensation plans
– can be provided exclusively for executives
– employer tax deduction deferred until benefit payments are
made
individual retirement savings plans
– can be alternative or supplement to employer plan
– amount of contribution limited
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
True or False?
1. An age-weighted plan allows for higher contribution
levels as percent of compensation for older plan
entrants.
2. A cross-tested plan maximizes benefits to highly
compensated employees.
3. An age-weighted plan can provide approximately the
same benefits to employees when their employer
switches from a defined benefit plan.
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
True or False?
4. An age-weighted plan and a target benefit plan must
have annual employer contributions.
5. Cross-tested plans do not need to meet
nondiscrimination rules since their structure
precludes discrimination.
6. A cross-tested plan is typically not advantageous
when many highly compensated employees are
relatively young.
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Cross-Tested/
Age-Weighted Plan
Chapter 21
Employee Benefit & Retirement Planning
Discussion Question
Discuss how an age-weighted or cross-tested plan
would work for
1. self-employed
2. shareholder employees of S corporation
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