Broker Check
Part III - New Comparability Plan FAQs

Part III - New Comparability Plan FAQs

December 12, 2019

Questions & Answers

Which employees do you have to include in your new comparability plan?

In general, to be "qualified" (i.e., tax exempt), a plan must meet employee coverage tests that demonstrate that the plan does not discriminate in favor of highly compensated employees. This test is met by having a plan that covers any or all highly compensated employees also cover a certain minimum number or percentage of the non-highly compensated employees. Under the most basic minimum coverage test, a plan may cover any or all of the highly compensated employees if it also covers a number of non-highly compensated employees which is at least equal to 70% of the percentage of highly compensated employees covered.

For example, if the plan covers 100% of the highly compensated employees, then the plan must also cover at least 70% of the non-highly compensated employees of the employer; or if the plan covers only 50% of the highly compensated employees, then the plan must also cover at least 35% of the non-highly compensated employees of the employer (70% of 50% is



With respect to those employees who are designated as eligible to be covered by the plan, the plan cannot impose age or service eligibility requirements longer than age 21 and one year of service. For eligibility purposes, a year of service generally means a 12-month period during which the employee has at least 1,000 hours of service.


Two years of service may be required for participation as long as the employee will be 100% vested immediately when the employee enters the plan. For eligibility purposes, one year of service means a 12-month period during which employee has at least 1,000 hours of service. If you want, you can impose less (but not more) restrictive requirements.


When does plan participation begin?

An employee who meets the minimum age and service requirements of the plan must be allowed to participate no later than the

earlier of:


  • The first day of the plan year beginning after the date the employee met the age and service requirements, or
  • The date six months after these conditions are met


What is a highly compensated employee?

For 2019, a highly compensated employee is an individual who:


  • Was a 5% owner of the employer during 2018 or 2019, or
  • Had compensation in 2018 in excess of $120,000 and, at the election of the employer, was in the top 20% of employees in terms of compensation for that year. (This $120,000 rises to $125,000 in 2019.)


How is compensation defined for the gateway test?

It depends. A new comparability plan must use the top-heavy definition of compensation [Section 415(c)(3)] to determine whether that plan satisfies the 5% minimum allocation gateway. The plan may not use the other definitions of Section 414(s) compensation that are allowed when testing for nondiscrimination under the Section 401(a)(4) nondiscrimination rules. The net effect of this may be to increase the required employer contribution for eligible NHCEs for new comparability plans using the 5% gateway (if the plan would otherwise use a less inclusive definition of compensation for allocation purposes).


However, the Section 415(c)(3) compensation definition does not apply if the alternative gateway (each NHCE receives not less than one-third of the highest allocation provided for any HCE) is met. In this case, the Section 414(s) definition of compensation is used to determine whether the plan is discriminatory under the cross-testing rules.


When do your employees have full ownership of the funds in their accounts?

In general, employer contributions either must vest 100% after three years of service ("cliff" vesting), or must gradually vest with 20% after two years of service, followed by 20% per year until 100% vesting is achieved after six years ("graded" or "graduated" vesting).


Caution: Plans that require two years of service before employees are eligible to participate must vest 100% after two years of service.


Tip: A plan can have a faster vesting schedule than the law requires, but not a slower one.


What happens if an employee leaves before becoming fully vested in his or her account balance?

The unvested amount (called the forfeiture) is left behind in the plan. Forfeitures can be used to reduce future employer contributions under the plan, or they can be added to remaining participants' account balances. The IRS requires that forfeitures be allocated in a nondiscriminatory manner. This usually requires forfeiture allocation in proportion to participants' compensation rather than in proportion to their existing account balances.


Do you need to receive a favorable determination letter from the IRS in order for your plan to be qualified?

No, a plan does not need to receive a favorable IRS determination letter in order to be qualified. If the plan provisions (both the written provisions and as implemented) meet IRS requirements, the plan is qualified and entitled to the appropriate tax benefits.


Nevertheless, without a determination letter, the issue of plan qualification for a given year does not arise until the IRS audits your tax returns for that year. By that time, however, it is generally too late for you to amend your plan to correct any disqualifying provisions. Consequently, a determination letter helps to avoid this problem because auditing agents generally won't raise the issue of plan qualification if you have a current favorable determination letter.


What happens if the IRS determines that your new comparability plan no longer meets the qualified plan requirements?

The IRS has established programs for plan sponsors to correct defects. These programs are designed to allow correction with sanctions that are less severe than outright disqualification. If, however, you are unable to correct the defects in your program appropriately, your plan may be disqualified. Loss of a plan's qualified status results in the following consequences:


  • Employees may be taxed on contributions when they are vested rather than when benefits are paid
  • Your deduction for employer contributions may be limited or delayed
  • The plan trust would have to pay taxes on its earnings
  • Distributions from the plan become ineligible for special tax treatment and cannot be rolled over tax free


Do you have fiduciary responsibility for your employees' new comparability plan accounts?

Yes. You have a fiduciary responsibility to exercise care and prudence in the selection and appropriate diversification of plan investments. However, your liability for investment returns may be significantly reduced if you allow participants to direct the investments of their own accounts. A plan is participant-directed if it:


  • Allows participants to choose from a broad range of investments with different risk and return characteristics
  • Allows participants to give investment instructions at least as often as every three months
  • Gives participants the ability to diversify investments generally and within investment categories
  • Gives each participant sufficient information to make informed investment decisions


Note that if you sponsor a participant-directed plan, you assume an additional responsibility — participant education. A balance must be struck between providing not enough — or too much — investment educational support for plan participants. Employee education is an issue to be carefully considered when implementing a qualified retirement plan.


Tip: The Pension Protection Act of 2006 created a new prohibited transaction exemption under ERISA that lets certain related parties ("fiduciary advisers") provide investment advice (including, for example, recommendation of the advisor's own funds) to profit-sharing (and other defined contribution) plan participants if either (a) the advisor's fees don't vary based on the investment selected by the participant, or (b) the advice is based on a computer model certified by an independent expert, and certain other requirements, including detailed disclosure requirements, are satisfied. The Act also provides protection to retirement plan fiduciaries where an employee's account is placed in certain default investments in accordance with DOL regulations because the participant failed to make an affirmative investment election.


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