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401(k) SOL UTIONS

Cross-tested 401(k) Profit Sharing Plan

How Small Business Owners Can Maximize Retirement Savings Using a Cross-tested 401(k) Profit Sharing Plan

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Tap Into the Power of Cross-Testings a small business grows and thrives, the excitement about the future sometimes

outpaces employees' ability to save for it, especially the owner. When businesses mature, adding 401(k) plan features like profit sharing can help

an owner share the fruits of success with the team they value. But what happens when a simple employer match or a standard profit sharing contribution—employer contributions that the owner can receive just like any other employee—isn’t enough for an owner to stay on track for retirement? There is a simple and elegant solution to help business owners save more: using cross testing in the 401(k) plan.

TABLE OF CONTENTS

3 What is a 401(k) Profit Sharing Plan?

5 A Cross-tested 401(k) Profit Sharing Plan in Action

7 Is a Cross-tested 401(k) Profit Sharing Plan Right for Your Business?

8 How to Start A Cross-tested 401(k) Profit Sharing Plan

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What is a 401(k) Profit Sharing Plan?f an employer would like to retain the freedom to choose how much they contribute to their employees' retirement accounts depending on the profits the business sees in a given year, then a profit-sharing plan is a good choice. A standard 401(k) with employer match requires employers to set a standard rate—maybe it’s 3% of an employee’s salary—at

which they will match the dollars employees choose to save. With a profit sharing plan, the employer is not committed to a contribution rate in the same way.

What are the advantages of profit sharing over a standard employer match?

Flexible contribution rates: A 401(k) with profit sharing offers a lot of flexibility when it comes to employer contributions. Contributions are made on an annual basis (as opposed to a standard employer match, which happens each pay period), and the employer has the ability to determine how much they’d like to contribute each year. There’s even flexibility when it comes to determining how much to give different employees, but more on that later.

Increased contribution potential: Adding profit-sharing to a 401(k) allows individuals to contribute up to the annual limits, which are currently $55,000. How? Each individual is only allowed to save up to currently $18,500 of their pre-tax income in their personal 401(k) account. However, employer contributions (like profit sharing) don't count toward that amount, and employers are allowed to contribute more than individuals. Profit-sharing means that when times are good, everyone can benefit.

The term “profit sharing” can refer to several different concepts, but in this context, we’re talking about a component that can be added to a 401(k) plan that allows an

employer to make flexible annual contributions for themselves and their employees.

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Several types of Profit Sharing:Not all profit sharing plans are cut from the same cloth. There are four different ways to implement and manage profit sharing in a 401(k) plan.

1All employees

treated the same:

In the most common setup, called "pro-rata," all employees receive the same contribution rate, which employers

determine each year, in terms of a percentage

of their salary.

4Flexible:

Sometimes referred to as “New Comparability”

profit sharing, cross-testing allows employers to create separate benefit

groups with their own contribution rates. In other words, different groups of

employees receive different contributions. This is the type of plan covered by

this white paper.

Determined by employee age:

Some profit sharing plans, known as “age-

weighted” plans, equate contributions to equivalent benefits at retirement age, which

means older employees will receive a higher

contribution rate.

3Integrated with social security:

Finally, “integrated” profit sharing plans will tie in with social security benefits, which makes it easier for plans with highly-compensated employees to pass compliance tests.

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Cross-testing allows owners of small and growing businesses to offer benefits to all employees without compromising retirement security.

Cross-testing at Work: Take, for example, a dentist who owns a small practice with five employees. Her pro-rata 401(k) plan with profit sharing offers every employee a 5% contribution from the company each year. This is a valuable benefit but it only ever allows the dentist to give herself an employer contribution of $13,000 per year and pass compliance tests. At age 55, the dentist would need to save more in order to maintain her standard of living in retirement.

By making a simple amendment to the practice’s 401(k) plan document, the profit sharing can be changed from a pro-rata plan to a cross-tested plan, which grants the dentist the flexibility to place herself into a different benefit group than the rest of her employees. With this one change, the dentist can increase the employer contributions to her own account to $36,000 per year without increasing contribution rates for her employees. The additional $22,000 per year to save and invest will make all the difference in keeping the dentist on track for her retirement.

Cross-tested Profit Sharing at Work in a 401(k)

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Cross-testing At Work: Helping Business Owners Save MoreWith a pro-rata profit sharing plan, the dentist is limited to $13,500 per year in 401(k) employer contributions for herself. Cross-testing reveals she could make $36,000 in employer contributions to her account—without changing her contributions to other employees.

OLD PLAN NEW PLAN

AGE SALARY PRO-RATA ALLOCATION %

PRO-RATA ALLOCATION $

CROSS-TESTED ALLOCATION %

CROSS-TESTED ALLOCATION $

Dentist 55 $270,000 5% $13,500 13.33% $36,000

Employee 1 50 $40,000 5% $2,000 5% $2,000

Employee 2 45 $35,000 5% $1,750 5% $1,750

Employee 3 35 $35,000 5% $1,750 5% $1,750

Employee 4 30 $35,000 5% $1,750 5% $1,750

Employee 5 30 $35,000 5% $1,750 5% $1,750

RESULTS

Increased contribution to owner $22,500

Increased contribution to employee 0

TOTAL ADDITIONAL RETIREMENT SAVINGS TO OWNER $22,500

any small business owners start 401(k) plans with profit sharing to benefit their hard-working employees. Sometimes, however, a basic 401(k) plan with profit sharing that treats every employee the same—including the owner—can make it challenging for the owner to stay on track for retirement.

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Is a Cross-tested 401(k) Profit Sharing Plan Right For Your Business?

Best practices for setting up a 401(k) profit sharing plan with cross-testingIf your business seems like a good fit for a cross-tested plan, there are some best practices you can follow to make sure cross-testing goes off without a hitch:

• Make ideal contributions to “Non-Highly Compensated Employees” (NHCEs): The IRS defines “Highly Compensated Employees” as anyone who owns 5% of the interest in a business or makes more than $120,000 per year.² The term “NHCE” refers to any other employee. As a general rule, cross-tested plans successfully pass these tests when NHCEs are given a minimum contribution of between 3% and 5%. Each situation is unique, but for the dentist, the ideal balance that would allow her to increase her own total contributions while passing tests was 5% for NHCEs and 13.33% for her.

• Make more money and be older than NHCEs: Because cross-testing looks at the benefit to each employee at the time of retirement, these plans generally work best when an owner makes more money than their NHCEs and is also older.

The dentist’s story is one example of a good cross-testing fit. Who else could benefit from cross-testing?

Small businesses: Since cross testing works best with a ratio of no more than 25 employees

for every one owner, businesses with small teams are ideal—especially when the owner wants to save more for retirement, but also wants to take care of their small team.

Small professional services firms: Cross-testing also works especially well for firms whose owners

are older than their employees, which is often the case for small service-based firms like medical offices, law firms, or engineering companies.

Growing companies: Some small companies start with 401(k) plans that feature pro-rata profit

sharing, but find it expensive to continue offering a flat contribution rate with each new hire. It’s an easy transition for these companies to switch to cross-testing, allowing them to contribute to new employees at different rates and control costs.

² https://www.irs.gov/retirement-plans/plan-participant-employee/definitions

Starting a Cross-tested 401(k) Profit Sharing Plan for Your Business

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Starting a Cross-tested 401(k) Profit Sharing Plan for Your Business

Under the right circumstances, the process of cross-testing a 401(k) plan with profit sharing can have a big impact:

• Profit sharing increases the owner's annual contribution limit from $18,500 to $55,000 currently.

• Cross-testing allows owners to increase their contributions without increasing contributions to their employees.

• Cross-testing offers even more flexibility than a pro-rata 401(k) with profit sharing.

If cross-testing sounds like the right fit for your profit sharing plan, or you think you might want to add a profit sharing component to your existing 401(k), know your profit sharing schedule—changes like this should be made by November to take effect the next year. If you want to adopt this provision to an existing 401(k) with profit sharing, all it takes is a simple plan amendment.

About Fisher Investments 401(k) Solutions

Fisher Investments 401(k) Solutions is dedicated to bringing superior retirement plan services to small and mid-sized businesses and their employees. Fisher’s unique service offering is built on 35+ years of successful wealth management experience and includes our flexible investing platform. Business owners will experience the benefit of ongoing support from a dedicated Retirement Counselor whose focus is making the management of a 401(k) retirement plan easier, while helping employees plan for a comfortable retirement.

Questions? Call us at 844-238-1247

© 2018 Fisher Investments. Investing in securities involves the risk of loss. Intended for use by employers considering or sponsoring retirement plans; not for personal use by plan participants.

Contact Fisher Investments to learn more about this easy update to your plan.