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comparability profit sharing plan
A recent addition to the types of plans available is the "comparability" profit sharing plan. This is similar to a conventional profit sharing plan in that the amount of the contribution is discretionary.

The allocation of the contribution takes into account both the employee class or group and wage of the participant. The intent of the new allocation method is to target contributions to pre-defined employee groups and allow employees who are closer to retirement to receive a bigger piece of the contribution. Since these employees have a relatively short period from now until retirement, they must save more to reach the same goals as younger participants. In essence, the comparability plans recognize that disparities in allocation which result from differences in age should not be penalized.

The plans work by changing the focus of nondiscrimination testing away from the current amount of the contribution and to the value of the benefit at retirement age. To measure this benefit value, each employee’s allocation is accrued with interest to normal retirement age and then converted into an equivalent life annuity. By dividing this benefit value by an employee’s compensation, we calculate an “accrual rate” to be compared with the accrual rates of others and grouped into “rate groups”. Plans pass the discrimination test on the basis of a comparison between the number of non-highly compensated and highly compensated employees who are in each rate group. These steps apply in general to comparability plans, although plans including permitted disparity become more complicated.

To realize the significance of this type of plan to a small business owner, consider the following example. Owner M runs a small incorporated firm with two employees, K and L, and has a profit sharing plan which is allocated on the basis of compensation. $58,000 is allocated in the fourth column below. If M were to amend the plan to be a cross-tested plan with permitted disparity, the allocation would be that of column five. Of course, the actual change in allocation for any plan will depend upon the ages and compensation of each participant.

    Name      Age    Compensation  Allocation using
Current Plan
Allocation using
Cross-Testing
  Difference  
Owner M55$200,000$40,215$53,000$12,785
Employee K40$60,000$10,671$3,000 (7,671)
Employee L30$40,000$7,114$2,000 (5,114)
Total$300,000$58,000$58,000
Owner% of Contribution69.34%91.38%


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