Adding employees: the nondiscrimination basics

A Cash Balance plan can favor the owners, but only so far. When there are employees, the plan has to pass tests showing it doesn't discriminate in favor of highly compensated employees. The design determines how much those tests cost (ie, how much the employees must receive in benefits to pass testing).

The tests, in plain terms

Test	Code section	What it asks
Coverage	410(b)	Does the plan cover enough non-highly compensated employees compared with HCEs?
Minimum participation	401(a)(26)	Does a defined benefit plan give a meaningful benefit to at least 50 employees, or 40% of the workforce if fewer (but never fewer than 2)?
Nondiscrimination in benefits	401(a)(4)	Measured as equivalent benefits, are HCEs getting a disproportionate share?
Top-heavy minimums	416	If key employees hold most of the benefits, do non-key employees get the required minimum?

How plans pass: cross-testing

The 401(a)(4) test can compare contributions and benefits on an equivalent basis, adjusted for each person's age. An owner in their 50s is closer to retirement than a 30-year-old employee, so a much larger contribution for the owner can still count as an equal benefit. This is called cross-testing.

When a Cash Balance plan is tested together with a 401(k) profit sharing plan, a minimum allocation for staff applies first, known as the gateway. In practice, that usually means a combined employer contribution for eligible staff of about 5% to 7.5% of pay, often delivered mostly through the profit sharing plan, with a small Cash Balance credit to satisfy 401(a)(26).

Design levers

Eligibility. Plans can require up to one year of service and age 21 before an employee participates.
Groups. Each owner or group can have a different pay credit, as long as the plan passes testing.
Staff demographics. Younger staff cost less to cover on a tested basis and can dramatically improve testing results.
Related businesses. Companies under common ownership, and affiliated service groups, are tested as one employer. Ask before assuming a separate company can be left out.

Example Proposal

Two owners and ten employees, with a Cash Balance plan paired with a 401(k) profit sharing plan.

	Age	Salary	Deferrals	Company contributions	Total
Owner 1	58	$360,000	$32,500	$348,492	$380,992
Owner 2	55	$360,000	$32,500	$307,509	$340,009
10 employees	–	$355,000	–	$33,626
Total company contributions				$689,627
Percentage to owners				95.12%

Company contributions include the Cash Balance allocations plus the profit sharing and safe harbor contributions from the 401(k) plan.