Our IRS-Approved prototype 401k plan allows for significant customization
Each LifeCycle 401k system includes an IRS-approved prototype 401k plan that we work with you to customize to your 401k needs. Ours is NOT a cookie-cutter 401k plan with take-it-or-leave it investments like with some 401k plans designed for small businesses.
Things your company defines for its LifeCycle 401k plan include:
We offer free help with understanding each of your 401k plan customization options, so you can make educated decisions as to what will be best for your company and its employees. For help with specific topics, we recommend completing the appropriate Order Form (use the tabs at the top of this page to access the relevant form) and mark "Unsure. Please contact..." for relevant items. Completing an Order Form IN NO WAY obligates you to purchasing anything; it simply gives us the information we need about your company's size, etc., to answer questions regarding your potential 401k plan.
Within parameters set by law, you can have us edit your 401k plan down the road, if you like. You are never locked into the decisions you find suitable today. (If any edits you later have us make to your 401k plan mean re-customization of your 401k plan administration software and/or amendment of your official 401k Plan Adoption Agreement, we reserve the right to charge a fee of up to $500 for system re-customization; re-customization fees are a function of the complexity of the system and document changes required, and in most case are less than $200, if not waived completely.)
Things your company defines for its LifeCycle 401k plan include:
Your 401k participation eligibility requirements
Your 401k employer matching contribution formula, should you choose to include such contributions
Your 401k employer profit-sharing contribution formula, should you choose to include such contributions
Your 401k employer qualified nonselective contribution formula, should you choose to include such contributions
The vesting formula(s) to be applied to any employer matching and/or profit-sharing contributions, should you choose to include such contributions (qualified nonselective contributions are, by law, 100% vested when made)
The 401k investments you want to offer
Your 401k loan policy, should you choose to include 401k loans in your 401k plan
Your automatic enrollment default investment choice and contribution rate, should you choose to
use automatic enrollment in your company plan
Whether or not your plan will be run by
the safe harbor method of 401k plan administration and, if so, applicable employer contribution formulas
We offer free help with understanding each of your 401k plan customization options, so you can make educated decisions as to what will be best for your company and its employees. For help with specific topics, we recommend completing the appropriate Order Form (use the tabs at the top of this page to access the relevant form) and mark "Unsure. Please contact..." for relevant items. Completing an Order Form IN NO WAY obligates you to purchasing anything; it simply gives us the information we need about your company's size, etc., to answer questions regarding your potential 401k plan.
Within parameters set by law, you can have us edit your 401k plan down the road, if you like. You are never locked into the decisions you find suitable today. (If any edits you later have us make to your 401k plan mean re-customization of your 401k plan administration software and/or amendment of your official 401k Plan Adoption Agreement, we reserve the right to charge a fee of up to $500 for system re-customization; re-customization fees are a function of the complexity of the system and document changes required, and in most case are less than $200, if not waived completely.)
Your customization options
The below chart shows the 401k plan customization options allowed by the government regulations (and therefore in LifeCycle 401k) and within that spectrum those typically recommended for a first-time plan.
Understanding the potential effect each option has on a 401k plan's popularity and thus its worth cannot be universally mapped out, as such vary with company size, worker preferences and other company-specific parameters. We are happy to discuss potential effects with you and recommend that interested parties submit the appropriate Order Form and use the "Unsure. Please contact..." buttons to indicate about which items you need more information. As explained in the No Money Due at This Time: The Order Fulfillment Process
section (see above), submitting an Order Form in no way obligates your company to placing an order.
| 401K PLAN PARAMETERS | IRS ALLOWS... | RECOMMENDATION FOR MOST LifeCycle 401k PLANS* |
| PARTICIPANT ELIGIBILITY: Age Requirement |
Anything from none to 21 years of age | 21 years of age (we recommend that participation begin on the first day of the first month after the person meets the plan's eligibility requirements) |
| PARTICIPANT ELIGIBILITY: Length of Service Requirement |
Anything from none to 1 year of service | 3 months of age (we recommend that participation begin on the first day of the first month after the person meets the plan's eligibility requirements) |
| PARTICIPANT ELIGIBILITY: Union Membership |
OK to exclude employees whose service is governed by a collective bargaining agreement | Exclude union employees |
| EMPLOYER CONTRIBUTIONS (Matching, Profit-Sharing and/or Qualified Nonelective) |
Cannot make total contributions to any employee account over the annually-adjusted total allowed contribution amount. For more information, see "401k Contribution Guidelines and Limitations" within our 401k Basics page. | Allowed in all forms but not mandatory. Contact us to discuss your particular situation. |
| VESTING OF EMPLOYER CONTRIBUTIONS | Full, immediate vesting OR anything less stringent than either: (a) No vesting earned until the person has participated in the plan for five years, then 100% vesting after five years, or (b) Seven Year Formula: 0% vested for the first 2 years of participation 20% vested after 3 years 40% vested after 4 years 60% vested after 5 years 80% vested after 6 years and 100% vested after 7 years of participating in the plan. |
Full, immediate vesting OR Five Year Formula: 20% vested after 1 year of participating in the plan 40% vested after 2 years 60% vested after 3 years 80% vested after 4 years 100% vested after 5 years of participating in the plan. |
| INVESTMENT OPTIONS | Almost anything goes (stocks, bonds, annuities, company stock, GIC insurance contracts, and more), but selection offered MUST fulfill plan sponsor's "fiduciary responsibility" with respect to offering ample variety, among other things, of 401k investment opportunities | Both individual no-load mutual fund families (including no-load institutional mutual funds) and self-directed brokerage accounts are allowable; see our Investments pages for information that will help you determine which (perhaps both) best suit your 401k needs. |
| 401K LOANS | Inclusion or exclusion is allowed. | Allowed but not mandatory. Not recommended for a plan's first year of operation. |
| AUTOMATIC (aka, Passive) ENROLLMENT | Allowed by the IRS, but the legal system has not yet had occasion to rule on possible infringements upon employee rights. | Allowed but not mandatory. No recommendation; consult your legal advisor. |
| *Understanding the potential effect each option has on a 401k plan's popularity and thus its worth cannot be universally mapped out, as such vary with company size, worker preferences and other company-specific parameters. We are happy to discuss potential effects with you and recommend that interested parties submit the appropriate order form and use the "Unsure. Please contact..." buttons to indicate about which items you need more information. As explained within "No Money Due at This Time: The Order Fulfillment Process" (see above), submitting an order form in no way obligates your company to placing an order. | ||
Additional recommended parameters
In addition to the above, we generally recommend the following for LifeCycle 401k plans:
| PLAN PARAMETER | RECOMMENDATION FOR MOST LifeCycle 401k PLANS* |
| PLAN YEAR | January 1 - December 31 |
| NORMAL RETIREMENT AGE | 65 |
| EARLY RETIREMENT AGE | No early retirement age |
| HARDSHIP WITHDRAWALS | Include (mandatory under IRS regulations) |
| PARTICIPANT ACCOUNT STATEMENTS | Monthly. With LifeCycle 401k, plan participants have the self-service freedom to view/print account statements at any time. |
| Understanding the potential effect each option has on a 401k plan's popularity and thus its worth cannot be universally mapped out, as such vary with company size, worker preferences and other company-specific parameters. We are happy to discuss potential effects with you and recommend that interested parties submit the appropriate order form and use the "Unsure. Please contact..." buttons to indicate about which items you need more information. As explained within "No Money Due at This Time: The Order Fulfillment Process" (see above), submitting an order form in no way obligates your company to placing an order. | |
The safe harbor administration option
The IRS offers an alternative means for achieving 401k plan balance: The safe harbor method of 401k plan operation lets 401k plans skip their annual 401k discrimination testing so long as the sponsoring employer meets certain employer 401k contribution requirements that are designed to ensure broad participation in the company plan; the employer, too, must provide 100% immediate vesting of the contributions.
The employer must provide annual information to employees explaining the 401k plan's safe harbor provisions and benefits, including that safe harbor contributions cannot be distributed before termination of employment and that they are not eligible for financial hardship withdrawal.
Your LifeCycle 401k system includes such notification within your customized 401k plan's Summary Plan Description, a document for prospective and active plan participants that's updated at least annually.
To qualify a 401k plan as a safe harbor plan, an employer must make matching contributions that fulfill the below requirements or make nonselective contributions equal to 3% of each eligible employee's compensation.
Nonselective contributions are made to all eligible employees, regardless of if the employees participate in the company 401k plan. Matching contributions, on the other hand, being based upon salary deferral amounts, are made only to active 401k participants' accounts.
If the employer chooses to make safe harbor matching contributions, those contributions must meet two requirements: First, each non-highly-compensated employee must receive a dollar-for-dollar match on salary deferrals up to 3% of compensation and a 50¢ to the dollar match on salary deferrals from 3% to 5% of compensation. Second, the rate of any matching contributions being made to highly compensated employees cannot exceed that being made to non-highly compensated employees.
The employer must provide annual information to employees explaining the 401k plan's safe harbor provisions and benefits, including that safe harbor contributions cannot be distributed before termination of employment and that they are not eligible for financial hardship withdrawal.
Your LifeCycle 401k system includes such notification within your customized 401k plan's Summary Plan Description, a document for prospective and active plan participants that's updated at least annually.
If you don't choose the safe harbor method of 401k plan administration, we encourage you to use your customized 401k plan administration software's point-and-click compliance testing every month to keep well apprised of your plan's health so there are no surprises when your plan is subjected to its mandatory year-end tests.
Monthly testing takes only seconds with LifeCycle 401k, and frequent testing means you can spot and correct undesirable trends before they compound.
You can test your company's 401k plan for compliance any hour of the day or night, and day of the week, from any computer with Internet access.
The Roth 401k plan option
As the name implies, a Roth 401(k) combines features of the traditional 401(k) with those of the Roth IRA. The Roth 401(k) is offered by plan sponsors alongside a traditional 401(k). Employees make contributions to the Roth 401(k) in addition to (or as an alternative to) making contributions to their traditional 401(k). Unlike a traditional 401(k) contribution, which is always pre-tax, all Roth 401(k) contributions are made with the employee's after-tax dollars. As with the traditional 401(k), the participant's Roth 401(k) contributions grow tax-free. But unlike traditional 401(k)s, withdrawals taken from the Roth 401(k) during retirement not subject to income tax, provided the account holder is 59 1/2 and the Roth 401(k) contributions have been held in the account for a minimum of five years.
The Roth 401(k) can offer advantages to high-income individuals who haven't been able to contribute to a Roth IRA because of the income restrictions. (Eligibility for 2009 phases out between $105,000 and $120,000 for single filers and $166,000 to $176,000 for those who are married and file jointly).
Roth 401(k) accounts are subject to the contribution limits of regular 401(k)s - $16,500 for 2009, or $22,000 for those 50 or older by the end of the year - allowing individuals to stock away thousands of dollars more in tax-free retirement income than they would through a Roth IRA. (In 2009, Roth IRA contributions are limited to $5,000 a year, or $6,000 for those 50 or older.)
The hitch: Those limits apply to contributions to both types of 401(k) plans, so participants can't save $16,500 in a regular 401(k) and another $16,500 in a Roth 401(k). Employees who are offered this option face a difficult choice: Contribute to a Roth 401(k) and suffer a cut in take-home pay (since contributions are made with after-tax dollars), or stick with a traditional 401(k) and hope that in retirement, their tax rate will be lower than it is now. Alternatively, they could hedge their bets by contributing to both accounts.
If the employee expects tax rates to be the same or higher in retirement than it is now, he or she might be better off with a Roth 401(k). This is likely to be the case with young people who are just starting their careers and expect their income to increase in the future. If the employee is in peak earning and anticipates his or her tax bracket will be lower in retirement, then continuing to use a traditional 401(k) is probably the best option. In reality, of course, things are much more complicated. For one, no one can predict with certainty what tax rates will be in the future, though the general consensus is that they're likely to rise to help the government offset growing budget deficits and pay for Social Security and Medicare.
No mandatory withholding for in-plan conversions of 401(k)s to Roth Rollovers. Plan sponsors who are allowing direct Roth rollovers from 401(k) and 403(b) plans into Roth Rollovers don't have to worry about mandatory withholding for those "distributions." According to a notice posted by the Internal Revenue Service on its website, mandatory 20% withholding does not apply to in-plan Roth direct rollovers.
More specifically, the IRS allows participants to make rollovers from their 401(k) and 403(b) plans to their designated Roth accounts (an "in-plan Roth rollover") after September 27, 2010. The taxable amount rolled over is includible in income equally in 2011 and 2012, unless the taxpayer elects to include it in 2010. The additional tax under section 72(t) does not apply to these rollovers.
The IRS says that the amount rolled over should be reported in box 1 (Gross distribution), the taxable amount in box 2a, and any basis in the rollover in box 5 (Employee contributions). Further, Code G in Box 7 on Form 1099-R should be used. The notice goes on to say that distributions made to plan participants in 2010 from designated Roth accounts must be reported on a separate Form 1099-R, and that the portion of a distribution from a designated Roth account that is allocable to an in-plan Roth rollover must be reported on a Form 1099-R. "Report the distribution as you would any other distribution from a designated Roth account; however, in the blank box to the left of box 10, enter the amount of the distribution allocable to the in-plan Roth rollover".
*For purposes of qualified distributions, disability must meet the definition stated in Internal Revenue Code Section 72(m) (7).
The Roth 401(k) can offer advantages to high-income individuals who haven't been able to contribute to a Roth IRA because of the income restrictions. (Eligibility for 2009 phases out between $105,000 and $120,000 for single filers and $166,000 to $176,000 for those who are married and file jointly).
Roth 401(k) accounts are subject to the contribution limits of regular 401(k)s - $16,500 for 2009, or $22,000 for those 50 or older by the end of the year - allowing individuals to stock away thousands of dollars more in tax-free retirement income than they would through a Roth IRA. (In 2009, Roth IRA contributions are limited to $5,000 a year, or $6,000 for those 50 or older.)
The hitch: Those limits apply to contributions to both types of 401(k) plans, so participants can't save $16,500 in a regular 401(k) and another $16,500 in a Roth 401(k). Employees who are offered this option face a difficult choice: Contribute to a Roth 401(k) and suffer a cut in take-home pay (since contributions are made with after-tax dollars), or stick with a traditional 401(k) and hope that in retirement, their tax rate will be lower than it is now. Alternatively, they could hedge their bets by contributing to both accounts.
If the employee expects tax rates to be the same or higher in retirement than it is now, he or she might be better off with a Roth 401(k). This is likely to be the case with young people who are just starting their careers and expect their income to increase in the future. If the employee is in peak earning and anticipates his or her tax bracket will be lower in retirement, then continuing to use a traditional 401(k) is probably the best option. In reality, of course, things are much more complicated. For one, no one can predict with certainty what tax rates will be in the future, though the general consensus is that they're likely to rise to help the government offset growing budget deficits and pay for Social Security and Medicare.
No mandatory withholding for in-plan conversions of 401(k)s to Roth Rollovers. Plan sponsors who are allowing direct Roth rollovers from 401(k) and 403(b) plans into Roth Rollovers don't have to worry about mandatory withholding for those "distributions." According to a notice posted by the Internal Revenue Service on its website, mandatory 20% withholding does not apply to in-plan Roth direct rollovers.
More specifically, the IRS allows participants to make rollovers from their 401(k) and 403(b) plans to their designated Roth accounts (an "in-plan Roth rollover") after September 27, 2010. The taxable amount rolled over is includible in income equally in 2011 and 2012, unless the taxpayer elects to include it in 2010. The additional tax under section 72(t) does not apply to these rollovers.
The IRS says that the amount rolled over should be reported in box 1 (Gross distribution), the taxable amount in box 2a, and any basis in the rollover in box 5 (Employee contributions). Further, Code G in Box 7 on Form 1099-R should be used. The notice goes on to say that distributions made to plan participants in 2010 from designated Roth accounts must be reported on a separate Form 1099-R, and that the portion of a distribution from a designated Roth account that is allocable to an in-plan Roth rollover must be reported on a Form 1099-R. "Report the distribution as you would any other distribution from a designated Roth account; however, in the blank box to the left of box 10, enter the amount of the distribution allocable to the in-plan Roth rollover".
| Traditional 401(k) Contributions | Roth 401(k) Contributions | |
| When you will pay taxes on your contributions |
You pay the tax upon withdrawal. Contributions are tax-deferred, so current taxes are reduced.
|
You pay regular income tax on your contributions before the money goes into your account. Current taxes are not reduced.
|
| When you will pay taxes on any investment earnings |
You pay taxes on the full amount of any distribution, including earnings, at ordinary income tax rates in effect upon withdrawal.
|
Your contributions have already been taxed, so there is no tax on them and no taxes on any earnings if you take a qualified distribution.
|
| Qualified distribution rules* |
Contributions and any earnings remain in account until age 591/2 or a separation from service that qualifies for retirement distributions. Withdrawals are subject to current ordinary income tax at withdrawal (and a 10% tax penalty may apply before age 591/2) unless the tax deferral is continued.
|
Contributions and earnings are distributed tax-free if they meet the requirements of a qualified distribution; earnings in a non-qualified distribution are subject to current ordinary income tax (and a 10% tax penalty may apply before age 591/2) unless the tax deferral is continued.
|
| Impact of contributions on take-home pay |
Since contributions are pre-tax, your current income tax is reduced and each $1 contributed reduces your take-home pay by less than $1.
|
Because you pay current taxes on your contributions, take-home pay is reduced dollar for dollar by your contributions.
|
| Rollovers from your account |
You may roll over your account balance upon termination to a traditional IRA, a 401(k) plan or another qualified employer-sponsored plan.
|
You may roll over your account balance upon termination to a Roth IRA or another Roth 401(k) or Roth 403(b) account in a qualified employer plan.
Note: For purposes of the 5-year rule for qualified distributions, the date of the initial contribution to a Roth IRA governs. |
| Taxes on employer match, if applicable |
Employer matching contributions are made on a pre-tax basis; contributions and any earnings are taxable upon withdrawal.
|
Same. The employer match is not treated as a Roth contribution.
|
| Required minimum distributions |
You must begin required minimum distributions by April 1 of the year following the year in which you reach age 701/2 or at retirement, if later.
|
You must begin required minimum distributions by April 1 of the year following the year in which you reach age 701/2 or at retirement, if later.
|
| Loan and hardship |
Account balances are available for 401(k) loans and hardship withdrawal if the plan allows.
|
Contributions are available for 401(k) loans and hardship withdrawal if the plan allows.
|
*For purposes of qualified distributions, disability must meet the definition stated in Internal Revenue Code Section 72(m) (7).
Cross-tested 401k plans, including "age-weighted" and "new-comparability" plan options
What is a cross-tested 401(k) plan?
There are several ways a 401k can be "tested" to determine its compliance with US Department of Labor regulations. If a 401(k) passes just one of several compliance tests, it is deemed "qualified" under the governmental regulations. If a 401(k) cannot pass any of the various compliance tests it is deemed "disqualified," which means the plan loses all its tax-advantaged benefits, resulting in serious tax problems for the employer and plan participants alike. It is essential that 401(k) compliance be checked frequently, and passes at least one compliance test annually.
The main compliance violation the government tries to guard against involves a plan that gives significantly disproportionate benefits to highly-compensated employees (HCEs) to the determent of the non-highly compensated rank and file (NHCs). An individual is a HCE if he or she earns over a certain dollar amount (e.g., $110,000 in 2009) or is a "more than 5% owner" in the business.
In the cross-testing methodology, the company's 401(k) profit sharing contributions to plan participants are converted mathematically to projected benefits at retirement. These projected benefits are then tested against each other to ensure that the plan does not discriminate in favor of HCEs. Our online software has 401(k) compliance testing "build-in" and available to be run anytime to monitor the plan's compliance status.
What is the advantage of a cross-tested 401(k) plan?
In comparison to other compliance tests, a cross-tested 401(k) permits substantially larger contributions be made to HCEs, or older participants, without violating compliance regulations.
Example: Suppose a 60 year-old business owner (HCE) has two younger employees, both non-highly compensated, and wants to make a large profit-sharing contribution to himself. In this example the business owner pays himself $100,000 annually, and he pays his two 30-year old employees $30,000 annually. If a standard profit-sharing contribution is allocated to the owner and the two employees, each individual will receive the same contribution percentage. In a cross-tested plan, however, the goal is to ensure that the contribution each individual receives will provide the same projected benefit at normal retirement age, generally age 65. To achieve this goal a larger contribution must be made for the 60 year old business owner than for the two 30-year old employees. The business owner has fewer years for the contributions to accumulate before he reaches age 65 and the contributions for the younger employees has 35 years to accumulate, so smaller contributions are made without violating non-discrimination regulations.
Must an employer make a contribution to a cross-tested 401(k) plan every year?
Yes, a minimum contribution for each participant is required if a contribution is made to the HCEs. Generally, the non-highly compensated employees (NHCEs) must receive an allocation for the year equal to the lesser of either 5% of compensation, or 33% of the highest contribution rate provided to any HCE.
If a contribution amount passes the test in one year, will the same contribution pass the test in the subsequent year?
Not necessarily. Because of employee attrition, new hires and the fact that employees grow older each year, a contribution that passed the nondiscrimination test in one year might not satisfy the test in the subsequent year. Therefore, the proposed contribution for each year must be tested in order to determine whether it would pass the test.
How is a cross-tested 401(k) plan designed?
Generally, a cross-tested 401(k) is designed by dividing the employees into two main groups, the most typical division being HCEs and NHCEs. In cross-testing the employer is permitted to make additional groups within these two main groups, and separate contribution amounts within each group. The employer then places the employees receiving the highest allocations in one group, and the other employees in the other groups. The employer can establish groups with characteristics unique to that group (e.g., highly compensated employees who are owners, highly compensated employees who are not owners, paralegals, etc.). Although the cross-testing rules do not impose any requirements for defining groups, the employer may not use criteria such as race, religion or gender.
Although the rules do not specify a method for allocation, the cross-tested plan typically allocates the profit-sharing contribution uniformly among employees within a given group. The employer will make a contribution to a specific group, and then allocate the contribution proportionately based on the compensation of all participants in that group. The separate contribution made for each of the other groups is allocated in the same manner (i.e., based on the compensation of all participants in the group).
How many cross-testing methods exist?
There are two distinct methods for cross-testing a plan. The original cross-testing method relied upon the age of plan participants in determining compliance. This method, called "age weighting" resulted in the following:
The second method for cross-testing is called "new comparability", and it differs from "age weighting" in the following ways:
Comparison of traditionally-tested 401(k) and a cross-tested 401(k). Notice how much more money the HCEs are able to receive in company profit-sharing contributions without violating DOL antidiscrimination rules.
There are several ways a 401k can be "tested" to determine its compliance with US Department of Labor regulations. If a 401(k) passes just one of several compliance tests, it is deemed "qualified" under the governmental regulations. If a 401(k) cannot pass any of the various compliance tests it is deemed "disqualified," which means the plan loses all its tax-advantaged benefits, resulting in serious tax problems for the employer and plan participants alike. It is essential that 401(k) compliance be checked frequently, and passes at least one compliance test annually.
The main compliance violation the government tries to guard against involves a plan that gives significantly disproportionate benefits to highly-compensated employees (HCEs) to the determent of the non-highly compensated rank and file (NHCs). An individual is a HCE if he or she earns over a certain dollar amount (e.g., $110,000 in 2009) or is a "more than 5% owner" in the business.
In the cross-testing methodology, the company's 401(k) profit sharing contributions to plan participants are converted mathematically to projected benefits at retirement. These projected benefits are then tested against each other to ensure that the plan does not discriminate in favor of HCEs. Our online software has 401(k) compliance testing "build-in" and available to be run anytime to monitor the plan's compliance status.
What is the advantage of a cross-tested 401(k) plan?
In comparison to other compliance tests, a cross-tested 401(k) permits substantially larger contributions be made to HCEs, or older participants, without violating compliance regulations.
Example: Suppose a 60 year-old business owner (HCE) has two younger employees, both non-highly compensated, and wants to make a large profit-sharing contribution to himself. In this example the business owner pays himself $100,000 annually, and he pays his two 30-year old employees $30,000 annually. If a standard profit-sharing contribution is allocated to the owner and the two employees, each individual will receive the same contribution percentage. In a cross-tested plan, however, the goal is to ensure that the contribution each individual receives will provide the same projected benefit at normal retirement age, generally age 65. To achieve this goal a larger contribution must be made for the 60 year old business owner than for the two 30-year old employees. The business owner has fewer years for the contributions to accumulate before he reaches age 65 and the contributions for the younger employees has 35 years to accumulate, so smaller contributions are made without violating non-discrimination regulations.
Must an employer make a contribution to a cross-tested 401(k) plan every year?
Yes, a minimum contribution for each participant is required if a contribution is made to the HCEs. Generally, the non-highly compensated employees (NHCEs) must receive an allocation for the year equal to the lesser of either 5% of compensation, or 33% of the highest contribution rate provided to any HCE.
If a contribution amount passes the test in one year, will the same contribution pass the test in the subsequent year?
Not necessarily. Because of employee attrition, new hires and the fact that employees grow older each year, a contribution that passed the nondiscrimination test in one year might not satisfy the test in the subsequent year. Therefore, the proposed contribution for each year must be tested in order to determine whether it would pass the test.
How is a cross-tested 401(k) plan designed?
Generally, a cross-tested 401(k) is designed by dividing the employees into two main groups, the most typical division being HCEs and NHCEs. In cross-testing the employer is permitted to make additional groups within these two main groups, and separate contribution amounts within each group. The employer then places the employees receiving the highest allocations in one group, and the other employees in the other groups. The employer can establish groups with characteristics unique to that group (e.g., highly compensated employees who are owners, highly compensated employees who are not owners, paralegals, etc.). Although the cross-testing rules do not impose any requirements for defining groups, the employer may not use criteria such as race, religion or gender.
Although the rules do not specify a method for allocation, the cross-tested plan typically allocates the profit-sharing contribution uniformly among employees within a given group. The employer will make a contribution to a specific group, and then allocate the contribution proportionately based on the compensation of all participants in that group. The separate contribution made for each of the other groups is allocated in the same manner (i.e., based on the compensation of all participants in the group).
How many cross-testing methods exist?
There are two distinct methods for cross-testing a plan. The original cross-testing method relied upon the age of plan participants in determining compliance. This method, called "age weighting" resulted in the following:
Profit-sharing contribution based upon participant's age.
Advantaged older plan participants and disadvantaged younger plan participants.
Resulted in HCEs getting unequal amounts of profit-sharing contributions.
The second method for cross-testing is called "new comparability", and it differs from "age weighting" in the following ways:
Profit-sharing contribution is based upon a participant's classification within the organization.
Advantages owners and key employees over all other plan participants.
Owners receive the same profit-sharing contribution amount.
Comparison of traditionally-tested 401(k) and a cross-tested 401(k). Notice how much more money the HCEs are able to receive in company profit-sharing contributions without violating DOL antidiscrimination rules.
| Employee | Age | Compensation | Traditional 401(k) PS Allocation | Cross Tested 401(k) PS Allocation |
| A (HCE) | 50 | $245,000 | $49,000 | $49,000 |
| B (HCE) | 45 | $245,000 | $49,000 | $49,000 |
| C (NHCE) | 40 | $40,000 | $8,000 | $3,538 |
| D (NHCE) | 32 | $35,000 | $7,000 | $1,750 |
| E (NHCE) | 28 | $28,000 | $5,600 | $1,400 |
| F (NHCE) | 25 | $20,000 | $4,000 | $1,000 |
| Total | $613,000 | $122,600 | $105,688 | |
You are never locked into your option decisions
You are never locked into your LifeCycle 401k plan and/or system design decisions. We have many clients that, for instance, exclude 401k loans in the early years of their plan, then add the option in at a later date.
Know that you can have us modify your plan and system design at any time. We do reserve the right to charge for changes initiated by you that require us to re-customize your 401k online software and/or official 401k documents. The maximum charge for re-customization work is $500 per instance and depends upon the complexity of the changes required; generally the fee is $200 or less.
Know that you can have us modify your plan and system design at any time. We do reserve the right to charge for changes initiated by you that require us to re-customize your 401k online software and/or official 401k documents. The maximum charge for re-customization work is $500 per instance and depends upon the complexity of the changes required; generally the fee is $200 or less.