A large professional services firm faced a requirement under the IRS comparability rules that could have cost it more than $2 million and reduced benefits to key partners. The firm, already a client, was contacted by Milliman shortly after the proposed regulations were issued and alerted to the potential ramifications for its plan.

The company maintained a defined contribution plan that covered three employee groups: partners, associates, and staff. Each group was eligible to contribute salary deferrals and receive matching contributions; however, the firm’s associates were excluded from the profit-sharing component. The partners’ profit-sharing amounts were maximized to the extent allowed by law via complicated annual discrimination tests.

The plan used IRS-sanctioned mathematical tests (referred to as cross-testing) to prove that the disproportionate profit-sharing contribution to partners versus the other employee groups was not discriminatory.

However, under the new IRS comparability rules, plans that previously used cross-testing must first satisfy some entry rules. These rules—on the surface—would require the firm to provide profit-sharing contributions to associates (with an annual price tag of $2.0 million) and to raise the staff profit-sharing contribution from 4% to 5% of pay. The firm could not afford to cover the associates and were reluctant to increase the staff profit sharing because the staff matching contribution had been increased earlier in the year to remain competitive.

Proactive examination reveals unique solutions

Milliman explained the new IRS regulations to the client so that it could understand the new comparability rules. We prepared proforma discrimination tests results to determine the likely profit-sharing contributions levels for partners and to obtain cost estimates for covering associates and increasing the staff profit-sharing contribution. The proforma test results provided the following solutions.

Restructuring not allowed? Create a new plan

Because new comparability rules specifically denied sponsors the ability to restructure within a plan, Milliman recommended creating a separate plan that mirrored the original plan—only for associates. By placing associates in their own plan, the firm avoided the cost of providing a profit-sharing contribution to associates.

We also recommended that the new associate-only plan be administered within the master trust, thereby saving the firm additional plan administrative and management costs, and participant access and communication costs.

Examining deferrals to make cross-testing possible

Under the new comparability rules, a plan may cross-test if:

1. the plan provides a 5% base contribution rate to nonhighly compensated employees (NHCEs), and

2. the contribution rate of the highly compensated employees (HCEs) is not more than three times the NHCE contribution rate (currently 4% for NHCE, creating a maximum HCE rate of 12%).

Milliman’s proforma test indicated that several partners’ profit-sharing rates exceeded 12% of pay; therefore, on the surface the firm would need to raise the staff profit-sharing contribution to 5%. However, we noticed that the HCEs whose profit-sharing rates exceeded 12% of pay also were not maximizing their salary deferrals, thereby increasing the profit-sharing contribution rate above 12% of pay.

Because making a deferral or receiving an employer contribution have the same effect on a partner’s earned income, Milliman recommended that the firm communicate to all partners that they maximize their salary deferrals. Compliance would make all of the HCE profit-sharing rates less than 12% of pay. The 12% rate is three times the NHCE rate; therefore, the plan could use cross-testing to support the higher profit-sharing rates for the HCEs without increasing the staff contribution from 4% to 5%.

Reaching compliance and successfully maintaining benefits

Milliman’s timely advice and ability to look beyond the surface allowed the firm to avoid a potential cost increase, which most likely would have resulted in benefit cutbacks to key partners. Our recommendation of a second plan within a master trust provided a seamless, transparent solution without changing the participants’ perception of the plan. The firm adopted the solution, as presented by the firm’s retirement committee and the Milliman team, prior to the effective date of the new rules.