Talk to Your Doctor…Er…TPA Firm about Cross-Testing

By David J. Kupstas, FSA, EA, MSPA

David J. Kupstas, FSA, EA, MSPA

David J. Kupstas, FSA, EA, MSPA Chief Actuary

You can’t have the TV on very long before one of those ads for the latest prescription drug comes on. “Ask your doctor whether Incredipill is right for you.”  Why would a commercial tell me to ask my doctor about a drug?  If the medicine is right for me, wouldn’t the doctor know to prescribe it?

If 401(k) plans had similar commercials during prime-time TV, they should say, “Ask your Third Party Administration firm whether cross-testing is right for you.”   Here, too, if cross-testing was right for a 401(k) sponsor, wouldn’t the TPA or other consulting firm have “prescribed” it already?  You would think so, but we have found that is all too often not the case.  (For the record, we think cross-testing is right for almost all defined contribution plans.)

Save on Contributions to Employees with Cross-Testing  

We will not get into the technical details today of how cross-testing works. We will just say that, for a majority of plans, using cross-testing can result in big savings on contributions to employees.

Without cross-testing, an owner wanting the maximum annual addition might be required to give 10% or 13% of compensation to his staff to satisfy the nondiscrimination rules. With a cross-tested plan, the outlay could be more like 4.5% of pay.  With a staff payroll of $100,000, the savings could be $8,000 per year.  With payroll of $500,000, the savings could be along the lines of $40,000.

With results like that, it seems obvious that every TPA firm should offer cross-tested plans for its clients, but some do not. The reasons are varied.  Some firms do not have the technical expertise or familiarity with the regulations.  Good retirement plan design is not a priority for these firms.  TPA work is ancillary to their main business, such as payroll processing or insurance.

Non-cross-tested plan types include “uniform allocation” and “integrated.” If a company sponsors one of these plans instead of a cross-tested plan, one of two things happens.  An owner wanting to max out his personal contributions has to also contribute a lot to the employees, as in the examples above.  Or, the owner may simply decide it's not worth the expense to max out.  If the company wishes to spend, say, 5% of compensation on profit sharing contributions, then 5% is what the owner himself will be able to receive personally.  The owner may not even know it is possible to get a bigger share of the pie if he changed to a different kind of plan.

Max Out Tax-Deductible Contributions Without Spending More

We have run across a number of cases where a firm has multiple partners who wish to get the maximum $53,000 annual addition but are unable to do so because it is too expensive to make the necessary contributions to the employees. By changing the plan to a cross-tested 401(k), these partners can have their tax-deductible contributions raised to the max without having to spend a single extra dime in contributions to employees. 

Ask Your TPA About Cross-Testing Today                                                                                

Every plan sponsor without a cross-tested plan should ask its TPA why a different kind of plan was recommended. If the answer is unsatisfactory, we invite you to ask us about cross-testing.  There is a good chance we will tell you it’s right for you.

Let's Talk Cross-Testing 

— Topics: 401(k), Retirement, Financial Planning