Cross Tested Profit Sharing Plan

Cross-testing is a plan design concept which allows a company to define classes of employees and contribute profit sharing contributions on a percentage basis to each class.  Cross-testing works best in a company which has a business owner who is slightly older than the rest of the employees.  Annually, the contribution formula must pass an average benefits test.  In addition to the average benefits test, the plan must also satisfy a minimum allocation gateway where each non-highly compensated employee (NHCE) in the plan has an allocation rate that is at least one-third of the allocation rate of the highly compensated employee (HCE) with the highest allocation rate, or, each NHCE receives an allocation percentage of at least 5% of the NHCE's compensation.

For clients who want to utilize cross-testing and safe harbor but want to contribute the minimum total amount and receive the maximum individual amount available, the owner would receive 9% of compensation and the other eligible employees would receive 3%, which passes the allocation gateway described above.

The Benefit

A cross-tested plan allows the business owner to allocate a higher contribution rate to the owner and other highly compensated employees while also providing a benefit to the rest of the employees.  In a typical cross-tested plan, HCEs receive a higher allocation rate, often 14% to 25% of compensation, while NHCEs, regardless of their age or years of service, receive comparatively lower allocation rates of 5% or less of compensation.  The business owner could also allocate different contribution percentages to different groups of employees in order to reward them differently.

In conjunction with a safe harbor 401(k) plan (see Safe Harbor 401(k) Plan article), cross-tested contributions allow the owners and highly compensated employees to maximize their employee 401(k) contributions up to the limit for the year without any testing issues. The cross-tested contributions also may allow the owners and highly compensated employees to maximize their total contributions for the year in accordance with the annual limit.

Numerical Example

In the example below we have demonstrated two business owners at different wage levels receiving the maximum 401(k) contribution amount of $18,000 plus $6,000 as a catch-up contribution by utilizing the Safe Harbor Non-Elective 3% contribution.  The company is also contributing Profit Sharing contributions of 1.42% to the employees and 10.21% to the owners, which are subject to the plan’s normal vesting schedule.  Under this scenario, the business owners receive 73% of the employer contributions.

Cross-Tested Profit Sharing with Safe Harbor Non-Elective 3% Example
        Safe Cross-  
        Harbor Tested  
Name Age Wages 401(k) 3% PS Total
Owner 1 57 265,000 24,000 7,950 27,050 59,000
Owner 2 56 100,000 24,000 3,000 10,137 36,137
Total Owners   365,000 48,000 10,950 37,260 96,210
Employee 1 49 75,000 0 2,250 1,065 3,315
Employee 2 43 40,000 0 1,200 568 1,768
Employee 3 48 60,000 0 1,800 852 2,652
Employee 4 52 55,000 0 1,650 781 2,431
Employee 5 37 30,000 0 900 426 1,326
Employee 6 33 25,000 0 750 355 1,105
Employee 7 39 35,000 0 1,050 497 1,547
Employee 8 36 30,000 0 900 426 1,326
Employee 9 34 20,000 0 600 284 884
Employee 10 27 28,000 0 840 398 1,238
Total Employees 398,000 0 11,940 5,652 17,592
Total Contributions   48,000 22,890 42,912 113,802
Percent to Owners   100% 47% 87% 85%


Set Up This Plan

To determine if a CBP can be right for your company, or to setup this plan for your organization, please complete our Online Questionnaire.

You may also complete the questionnaire offline by downloading the form here and then faxing the completed form to our office.