How New Comparability 401(k) Plans Benefit Small Business Owners
New comparability 401(k) plans are set up so that employers can create customized retirement plan contributions for different groups of employees. This allows them you reward select groups with higher contributions while still offering healthy employer contributions to others.
Known as a qualified defined contribution plan, the profit-sharing formula works by projecting out an employee’s current contribution to a future retirement-age benefit.
How Do New Comparability Plans Work?
New comparability profit sharing plans offer compliance with 401(k) nondiscrimination laws, while allowing larger contributions to older participants — particularly owners and highly compensated employees.
- Employees are divided into groups
- Each group can receive a different level of profit share contribution, determined annually
- For nondiscrimination tests, the value of contributions at retirement age factors in
- In essence, 15% to a 55-year-old can be as valuable as 5% to a 30-year-old
- Non-HCEs receive a gateway minimum contribution (1/3 the highest rate or 5% of their pay)
New comparability plans can be combined with Safe Harbor plans, but the gateway minimum contribution must still apply, even if your company makes a 3% non-elective contribution already.
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New Comparability Plan Benefits for Small Businesses
Maximum HCE Retirement Savings:
If your small business has a disproportionate number of owners and key employees, it can be difficult to reach the combined limit for 401(k) plan contributions. Small businesses may delay or decline profit sharing contributions due to the financial burden of pro-rata allocations that are seemingly costly.
However, by giving different rates to different employee groups, business owners can be sure everyone gets their fair share. Small business owners can contribute to their own small business 401(k) accounts as both employer and employee. The maximum any employer can put away for 2023 is $66,000 ($22,500 as an employee + $43,500 as the employer), PLUS $7,500 for those age 50 or older.
With a flexible new comparability plan, small business owners can opt to offer a profit share on a good year and forego or reduce it during years of lower return or heavy investment. The contributions may also increase or decrease from year to year, at your discretion and depending on your business situation and goals.
Employer contributions are not subject to payroll tax and are generally tax deductible. This helps to lower the company’s overall tax burden for the year, as well as the business owner’s personal income tax rate.
Rewards for Older Employees:
As a small business owner, you may be older than most of their workforce and earn a higher salary. Choosing a new comparability plan may make sense for your personal finances. This choice of plan also rewards an experienced executive team.
Rewarding loyalty and longevity is another main reason small business owners offer 401(k)s, particularly these days when job-hopping is the norm and talent retention can be such a challenge. As key employees get older, they will no doubt be thinking about their own retirements and how they might grow their assets at a quicker pace.
Is a New Comparability Plan Right for Your Small Business?
Small businesses can benefit from a new comparability plan, though they may not be ideal for outfits with a highly fluctuating workforce. Changes in enrollment numbers could impact funding costs. Also, keep in mind these plans must pass a special IRS nondiscrimination test. This test proves that highly compensated employees aren’t being treated overly favorably in the retirement plan setup — as opposed to a Safe Harbor plan, which automatically passes testing.
Questions? Contact Ubiquity to explore all of your small business retirement plan options.