Although most people refer to this as a new comparability 401(k), it’s actually just an optional provision to a regular 401(k) plan. This provision is designed to enable employers to create customized retirement plan contributions for different groups of employees. This allows them you reward select groups with higher contributions while still offering 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 on average 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
- Non-HCEs receive a minimum gateway contribution (generally 1/3 the highest rate or 5% of their pay)
- One of the nondiscrimination tests looks at the value of contributions at retirement age
- In essence, 15% to a 55-year-old can be as valuable as 5% to a 30-year-old
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. The 3% Safe Harbor nonelective is used towards the nondiscrimination testing, whereas Safe Harbor match does not.
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. This option also allows the employer to refrain from contributing so some HCEs if they choose to.
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.
Plan Flexibility:
With a flexible new comparability plan, small business owners can opt to offer a discretionary 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.
Tax Deductibility:
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 Employees Nearing Retirement:
As a small business owner, you may closer to retirement than most of your 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 get closer to retirement, they will no doubt be thinking about 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 special IRS nondiscrimination tests. These tests ensure that highly compensated employees aren’t being treated overly favorably in the retirement plan setup — as opposed to a Safe Harbor plan, which generally satisfies most nondiscrimination testing.
