HYBRID DEFINED CONTRIBUTION Plans—more commonly called Cross-Tested Plans—are relative newcomers and seek to offer some of the benefits of defined benefit plans while retaining their defined contribution characteristics. These profit-sharing plans are used as a flexible way for business owners and highly-compensated or older employees to receive a maximum allowable contribution amount in a defined contribution plan—the lesser of 25% of compensation or $46,000 annually—while giving a different percentage amount to other employees. Most profit sharing plans, by contrast, use a pro-rata formula, which means the same percentage for all employees.

Most people are uninformed about these options, and while there are some plan administration expenses involved with adopting these plans, the owner can more than makes up the difference in increased, tax-deferred contributions to his own retirement plan. Financial Advisors probably have a number of clients who work for businesses that might be very interested to learn more.

Age-Weighted Profit Sharing Plans

The Age-Weighted profit sharing provision is a profit sharing allocation design that allows employers to make contributions based on an employee’s age as well as salary. The Age-Weighted profit sharing plan works in much the same way as a traditional profit sharing plan. Both plan designs have the same contribution limitation, are governed by the top-heavy and non-discrimination rules, and provide benefits that are equal to participant vested account balances.

The purpose of an Age-Weighted profit sharing plan, however, is to maximize the contributions for older employees while limiting contributions for younger employees. This is achieved through an allocation formula that considers age as well as salary rather than salary alone, as in a traditional profit sharing plan.

Since contributions are allocated among eligible employees on the basis of age and compensation, Age-Weighted plans are more like defined benefit plans, but with the discretionary flexibility of a profit sharing plan. Unlike in defined benefit plans, the participant retains control of the account and makes his or her own investment decisions.

New Comparability Profit Sharing Plans

The New Comparability “New Comp” profit sharing provision gives a larger percentage to one class of employees while giving a smaller percentage to another. This design best benefits companies with large salary disparities between employees and owners. A selected group of employees receives a higher profit sharing contribution than the other employees. Discrimination in these plans is examined on a benefits basis rather than on a contribution basis. Contributions are converted to “benefits” and the benefit accrual rate is tested.

If the plan does not provide for broadly available allocation rates or age-based allocation rates, the employer contributions must meet a gateway threshold. This gateway is satisfied if (1) the allocation rate to the Non-HCEs is at least one-third the allocation rate to the HCEs or (2) if the allocation rate to the Non-HCEs is at least 5% of the Non-HCE’s compensation.

These plans allow select groups to maximize contributions. They are an excellent alternative or replacement for a defined benefit plan, and let the employer vary the discretionary annual contributions up to 25 percent of net compensation for HCEs while giving a lower percentage to non HCEs. These plans work best when the average age of the target group is greater than the average age of the other employees.

The workforce is divided into two or more different groups of employees—for example highly-compensated (HCEs) and non highly-compensated employees. The contribution percentage is different among the HCEs and Non-HCEs. The percentages are determined such that the plan is non-discriminatory as governed by regulations issued by the Internal Revenue Service. Generally the plan is found to be non-discriminatory because the HCEs are typically older than the Non-HCEs.

Super New Comparability Plans
Many companies that have faced challenges meeting non-discrimination testing and top-heavy requirements have found the Super New Comp plan to be a welcome addition to their retirement plan options. Super New Comp plans combine aspects of Safe Harbor 401(k) plans and New Comparability plans to provide the employer with the ability to make maximum contributions, both salary deferrals and employer contributions, for highly-compensated employees. Benefits include:

• Allows employees to make annual 401(k) pre-tax salary deferrals, up to a maximum of $15,500 annually
• Non-discrimination and top-heavy testing is not required for Safe Harbor employer matching contributions
• Discretionary profit sharing contributions are permitted
• Enables maximum contributions and salary deferrals for the owner and highly compensated employees while minimizing out of pocket expenses to other employees

Although the Safe Harbor 401(k) allows employers to select either a 3% profit sharing contribution or a 4% match on a 5% deferral, the match is not taken into account for the purpose of the gateway. Therefore, employers rarely use the matching contribution option when establishing this type of plan as it will result in higher contributions to the Non-HCEs.

A flat 5% contribution to the Non-HCEs will satisfy both the gateway and the Safe Harbor requirement. The employer contribution must be made each year to maintain Safe Harbor provisions. Key advantages include no 401(k)-type discrimination testing, participant loans can be allowed, and all Safe Harbor contributions are 100% immediately vested.

Super New Comparability = Safe Harbor + New Comparability

Total Employer Contributions        $61,200

* Employer defers 15.50% and Employees defer 5% of compensation

** Employer receives 25.50% and Employees receive 5% of compensation

This is for illustrative purposes only. Individual results may vary.

Summary

Age-Weighted, New Comparability, and Super New Comparability plans can be particularly advantageous to business owners and key employees who are often older and more highly compensated than the rest of the employees. The plans are, however, somewhat complex and can be more expensive to administer than Traditional and Safe Harbor 401(k) plans.

Important Hybrid Plan Facts & Information

• Used to help owners and HCEs max out at $46,000 annually (as indexed)

• Profit Sharing Allocation Formula Considerations

—       Pro-Rata: same % to all eligible employees

—       Age Weighted: larger percentage to older vs. lower percentage to younger employees

—       New Comparability: different % to different classes of employees

Who Is Interested In This Type Of Plan?

§         The Age Weighted plan works well where the owners of a business are older, on average, than non-highly compensated employees and have been employed longer by the employer.

§         The New Comparability plans work well when there is a large difference between the compensation levels of two or more distinct groups of employees and works best when the average age of the HCEs is greater than the average age of the Non-HCEs.

Ideal Profile

Ø       25 or fewer employees

Ø       Owner earns more than $100,000

Ø       Owner wants to save more than $15,500 while minimizing out of pocket expenses to everybody else

Ø       Small Professional Businesses

o        Doctors, Lawyers, Accountants

Ø       Any business owner who wants to max out contributions automatically without worrying about employee participation

Ø       Existing Traditional 401(k) plans where owners consistently get refunds or corrective distributions

o        Failing ADP testing

Ø       Existing SEP Plans that are not grandfathered

o        Post-1996 SEP allows for employer contributions only

Ø       Existing SIMPLE IRA Plans

o        SIMPLE IRA has lower limits than 401(k)

If you have any questions about these plans or have clients who may be interested, please feel free to contact the Polaris401(k) at 877.814.401k.

A prospectus for the underlying investment options is available by calling 877-814-401k. The prospectus contains the investment objectives, risks, fees, charges, expenses and other information regarding the underlying funds, which should be considered carefully before investing. Please read the prospectus carefully before investing. The unallocated group variable annuity funding Polaris401(k) is an unregistered product without a contract prospectus.

Variable annuities are issued by AIG SunAmerica Life Assurance Company, except in New York. AIG SunAmerica Life Assurance Company is a subsidiary of AIG Retirement Services, Inc. and a member of the American International Group, Inc. (AIG) family of financial services companies. The purchase of a variable annuity is not required for, and is not a term of, the provision of any banking service or activity. Neither AIG SunAmerica nor its representatives provide tax or legal advice. Clients should contact their own tax advisor or attorney regarding their particular situation. Distributed by AIG SunAmerica Capital Services, Inc. 21650 Oxnard St., Woodland Hills, CA 91367 (800) 445-7862

Not FDIC or NCUA/NCUSIF Insured.   No Bank or Credit Union Guarantee.    May Lose Value.

 K-4538-AR4 (02/08)
 

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