Adding a Cash Balance Plan to a Profit-Sharing 401(k) Plan

Editor note: This story appeared in the Spring 2024 Plan Consultant magazine issue.

When a client informs your firm that they’re adopting a cash balance (CB) plan alongside their existing profit sharing 401(k) (PS/k) plan, it’s crucial to understand the implications and necessary adjustments.

Okay, your firm administers a profit sharing 401(k) (PS/k) plan for a client and they tell you they have decided to adopt a cash balance (CB) plan. Presumably, some design analysis or illustration was presented to them by a salesperson, and they’ve told you they intend to proceed. For purposes of this article, I’ll assume that an actuary or someone other than you will be handling all aspects of the CB plan, and your concerns are what changes need to be made to the PS/k plan document and what the administrative issues affecting the PS plan that you need to be aware of given the addition of the CB plan. 

Your first concern will be whether any changes need to be made to the PS/k document or adoption agreement. There are a few main issues to consider here:

• Highly Compensated Employee (HCE) Definition: Both plans must use a consistent definition for determining HCEs. Make sure you know how the combo plan was designed in this regard and if necessary, amend the PS/k plans HCE definition to match what’s being used in the CB plan. 
• PS Allocation Method: The combo plan design will almost always require that you amend the PS/k plan to use individual allocation groups. Without this, it is often impossible to make the plan design work because different levels of PS contributions will be required for HCEs and non-highly compensated employees (NHCEs), and often, additional contributions will need to be made to select NHCEs to get the combined testing to pass.
• PS Allocation Requirements: The combo plan design will operate most efficiently if no allocation requirements are associated with the PS contribution. 

This is because there may be statutory contributions required for NHCEs to satisfy the top-heavy contribution requirements and the dual plan gateway requirements, and these statutory contributions will override a last-day employment or 1000-hour requirement. 

• It’s understandably very confusing to clients when you tell them they have to make PS contributions for employees who don’t satisfy the plan document’s allocation requirements. With individual allocation groups, they are not compelled to make PS contributions for anyone but have the ability to make the required statutory contribution for everyone they are required.
• Top-Heavy (TH) Minimums: Both plan documents need to specify in which plan the TH minimum contribution will be made in the event the plans are top heavy. In almost all cases, the dual plan TH minimum will be provided in the PS/k plan, so the PS/k plan document will need to be amended accordingly. 
• Vesting: The slowest vesting schedule allowed for a CB plan is the three-year cliff vesting schedule. Under the regulations, this is considered comparable to the six-year 2/20 vesting schedule commonly used on the PS plan, so there is no issue with the two plans using these different vesting schedules.
• Other Benefits, Rights and Features: When two plans are tested together for non-discrimination testing purposes, they are then tested together for all other purposes. So things like timing of distributions, availability of in-service distributions and participant loans, and optional forms of benefits must provide in each plan in a non-discriminatory manner. 
• While not required, the administration of the two plans is way simpler and less prone to errors if both plans use a consistent compensation definition and a consistent definition for eligibility and entry dates. 
• In my experience, the best thing to do when your client tells you they are adding a CB plan is to send the existing PS/k plan document to the actuary and ask them to review it and tell you what changes need to be made.

Now, let’s consider the administrative issues that will affect the administration of the PS/k plan:

• Firstly, it’s critical that you and the sponsor realize that the profit-sharing contributions to the Non-Highly Compensated Employees (NHCEs) are no longer discretionary. In almost all cases, the CB plan and the PS/k plan have been designed to be tested together for non-discrimination purposes, which means the contributions for the NHCEs are required to pass non-discrimination testing each year.

One of the most common compliance issues that happens in these combo plan situations is when the sponsor makes advance PS contributions during the plan year. This can blow up the client’s ability to deduct the planned cash balance contribution!

• Suppose the CB plan is covered by the Pension Benefit Guaranty Corporation (PBGC). In that case, there is no combined deduction limit – the CB plan has its own deduction limit, and the PS plan has its normal 25% Compensation deduction limit. But suppose the CB is exempt from PBGC coverage. In that case, the employer contributions (the total of employer matching contributions, Safe harbor non-elective contribution and profit-sharing contributions) made during the plan year must not exceed 6% of compensation! As a quick refresher, owner-only plans and professional service organizations with less than 25 active participants will be exempt from PBGC coverage. If the plan is not covered by PBGC and the client has made employer contributions of more than 6% of compensation during the plan year. The combined deduction limit becomes 31% of compensation and they may have blown up their ability to deduct the planned cash balance contribution! You need to know if there is a combined deduction limit and if the employer contributions must be limited to 6% of compensation. If that’s the case, tell the client never to refund profit-sharing contributions until after year-end!
• For this same reason, it’s often better not to provide the Safe Harbor contributions to HCEs so that there is room within the 6% deduction limit to make the required statutory combined gateway requirements to the NHCEs. It’s also for this same reason that a Safe Harbor contribution is best provided by the 3% non-elective safe harbor if there is a combined deduction limit since the 3% non-elective SH contribution does triple duty – it goes towards the usual 5% TH dual plan contribution, it goes towards the combined gateway requirement, and it’s also used for non-discrimination testing. 
• Each year, the top-heavy test will now need to consider the cash balance accounts for the Key and Non-Key employees in combination with their PS/k plan balances. Usually, the actuary will ask you for the PS/k plan balances to compile the combined TH test to determine if the plans are top-heavy, or they will ask you to compile a combined test. If the plans are top-heavy, they will take the required TH minimum contributions required for the non-keys into account.
• When there is a combo CB and PS/k arrangement, you should only communicate PS contribution information to the client once the actuary has completed the combined testing and told you what the PS contributions are for the year. For the two plans to operate smoothly, you and the actuary need to be communicating with each other to ensure that you are both on the same wavelength with respect to what PS contributions are desired for the HCEs and what PS contributions are required for the NHCEs. Communication is key to keeping both plans operating smoothly!

Norman Levinrad is President of Summit Benefit & Actuarial Services.

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