When can it be used?
Generally, any employer is eligible to set up a new comparability plan
While just about any employer can set up a new comparability plan, it is most suitable for businesses with owners and principals who:
- Want the contribution flexibility of a profit-sharing plan, and
- Are older, on average, than their other employees and
- Want the biggest possible share of the plan contributions allocated to their own accounts
Example(s): A CPA firm has 10 senior partners, 20 junior partners, and 50 administrative staff. The senior partners want a profit-sharing plan that allows maximum allocations to their own individual accounts, with much lower amounts for the junior partners and other staff. If the highly compensated senior partners are significantly older on average than the junior partners and staff, a new comparability plan with not two but three participant classes: senior partners, junior partners, and administrative staff members, could be the right plan for this firm.
How do you implement it?
A number of complex rules govern new comparability plans. Consequently, you will need a pension specialist to help you develop and maintain a plan. In setting up and maintaining the plan, you will need to:
- Determine the plan features most appropriate for your business
- Have calculations done each year to determine the correct allocation of contributions
- Choose the plan trustee
- Choose the plan administrator
- Submit the plan to the IRS for approval
- Adopt the plan during the year in which it is to be effective
- Provide a copy of the summary plan description to all eligible employees
- File the appropriate annual report with the IRS
Strengths
You can maximize your contributions for yourself and other highly compensated employees
Because of the way a new comparability plan is tested for nondiscrimination, it is generally possible to allocate a higher portion of contributions to owners, highly compensated employees, and key employees. This is particularly true if these participants tend to be older than other employees.
Your contributions are flexible
Unlike money purchase, target, and defined benefit plans, a new comparability plan, like other profit sharing plans, allows you the flexibility to determine each year how much or how little you want to contribute to the plan (subject to maximum contribution limitations as well as the requirement that, overall, contributions must be recurring and substantial). Consequently, if your business is not doing well, you can decide not to contribute one year and if business turns around down the road, you can decide to make a contribution for that year and subsequent years.
Your contributions are tax deductible
You may deduct any contributions you make to the plan up to 25% of the compensation paid to plan participants (in calculating payroll, an individual's compensation is limited to $280,000 in 2019, up from $275,000 in 2018.
Your contributions are tax deferred for your employees
Your contributions to the plan are not taxable to plan participants until withdrawn.
Tip: Your employees may generally defer taxation by rolling over distributions (other than required minimum distributions, hardship distributions, and certain periodic payments and corrective distributions) to an IRA or to certain other employer retirement plans.
Caution: When considering a rollover, to either an IRA or to another employer's retirement plan, your employees should consider carefully the investment options, fees and expenses, services, ability to make penalty-free withdrawals, degree of creditor protection, and distribution requirements associated with each option.
Investment earnings accrue tax deferred
Investment earnings accumulate tax deferred and are not taxed to your employees until the benefits are paid.
Distributions from your plan may be eligible for special tax treatment
If a plan participant elects to take a lump-sum distribution, the participant's distribution may be eligible for special tax treatment.
Tradeoffs
Annual additions to each participant's account are limited
Like any other defined contribution plan, the annual additions — that is the contributions plus forfeitures — to each employee's account are limited to the lesser of 100% of compensation or $56,000 (in 2019). See Questions & Answers for the definition of "forfeiture." This limits the relative amount of funding for highly compensated employees. In contrast, a defined benefit plan may allow a much higher level of employer contributions for older employees.
Your plan is subject to "top-heavy" requirements
A plan is considered to be "top-heavy" if more than 60% of the benefits or contributions in the plan belong to the key employees (generally, the owners and officers of the business). If the plan is top-heavy, you must make a minimum contribution of 3% of pay to the accounts of all non-key employees.
The plan is subject to federal reporting, disclosure, and other requirements
A new comparability plan is subject to the federal reporting, disclosure, and other requirements that apply to most qualified plans under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code.
Tip: ERISA doesn't apply to governmental and most church retirement plans, plans maintained solely for the benefit of non-employees (for example, company directors), plans that cover only partners (and their spouses) and plans that cover only a sole proprietor (and his or her spouse).
How to do it
Have a plan developed for your business
Due to the complex nature of the rules governing qualified benefit plans, you will need a pension specialist to develop a plan that meets legal requirements as well as the needs of your business. You will need to:
- Determine the plan features most appropriate for your business: Carefully review your business, looking at factors such as your cash flow and profits, tax deduction needed, and current and future expected employee population (tenure, ages, salaries, turnover), to determine plan features.
- Choose the plan trustee (this may or may not be you): The assets of the plan must be held in trust by a trustee. The trustee has overall responsibility for managing and controlling the plan assets, preparing the trust account statements, maintaining a checking account, retaining records of contributions and distributions, filing tax reports with the IRS, and withholding appropriate taxes.
- Choose the plan administrator: Administering the plan involves many duties, including managing the plan (determining who is eligible to participate in the plan, the amount of benefits, and when they must be paid), and complying with reporting and disclosure requirements. The plan administrator may also be responsible for investing plan assets and/or providing informational and required investment educational services to plan participants. The employer is legally permitted to handle these responsibilities in-house, but plan sponsors will frequently hire a third-party firm or financial services company to assist in performing the functions of plan administration.
Submit the plan to the IRS for approval
Once a plan is developed, if it is not a prototype or similar plan pre-approved by the IRS, it should be submitted to the IRS for approval. Since there are a number of formal requirements (for example, you must provide a formal notice to employees), a pension specialist should assist you in this task. Submission of the plan to the IRS is not a legal requirement, but it is highly recommended. The IRS will carefully review the plan and make sure that it meets all legal requirements. If the plan meets all requirements, the IRS will issue a favorable "determination letter." If the plan does not meet all requirements, the IRS will issue an adverse determination letter indicating the deficiencies in the plan.
Adopt the plan during the plan year in which it is to be effective
A corporation "adopts" a plan by a formal action of the corporation's board of directors. An unincorporated business should adopt a written resolution in a form similar to a corporate resolution.
Provide a copy of the summary plan description (SPD) to all eligible employees
ERISA requires you to provide a copy of the summary plan description (SPD) to all eligible employees within 120 days after your plan is adopted. A SPD is a booklet that describes the plan's provisions and the participants' benefits, rights, and obligations in simple language. On an ongoing basis you must provide new participants with a copy of the SPD within 90 days after they become participants. You must also provide employees (and in some cases former employees and beneficiaries) with summaries of material modifications to the plan. In most cases you can provide these documents electronically (for example, through email or via your company's intranet site).
File the appropriate annual report with the IRS
Most qualified plans must file an annual report (Form 5500 series) with the IRS.
The information in this newsletter is not intended as tax, legal, investment, or retirement advice or recommendations, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented, nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Broadridge Advisor Solutions. © 2019 Broadridge Investor Communication Solutions, Inc. CRN202110-255702