Enhancing an age-weighted profit-sharing plan.

• Author: Gerber, Norman

A profit-sharing plan that uses an age-weighted allocation method can significantly improve the level of benefits provided to a business owner over those based on more conventional allocation techniques. With proper planning, particularly in determining the appropriate interest assumption for the present value factor and the adjustments necessitated by the maximum benefit limitations, the age-weighted allocation method can be even more beneficial to the plan sponsor.

The age-weighted profit-sharing plan relies on a contribution allocation technique that evolved from the "cross testing" rules set forth in Sec. 401(a)(4). The cross testing rules are intended to help determine comparability of benefits between defined contribution plans and defined benefit plans. This is analogous to the ageweighted a]location in that the allocation resu]t, for testing purposes, converts to an equivalent benefit unit, similar to a defined benefit plan funded to normal retirement age on a unit credit basis.

A simple method for making the age-weighted allocation is as follows.

1. For each participant, obtain a "present value factor" (PV factor) equal to the participant's current compensation multiplied by 1/ {1 + i} to the "nth" power, in which "i" is an assumed interest rate {not less than 7.5%, nor more than 8.5%1 and "n" is the normal retirement age under the plan minus the participant's current age.

2. Divide the contribution to be allocated by the sum of the PV factors. This will result in an "allocation factor."

3. Multiply each participant's PV factor by the allocation factor.

4. The result is the participant's preliminary contribution allocation.

   The schedule shown above illustrates the result of using the age-weighted allocation in comparison to a contribution of 10% of pay allocated in a straight compensation ratio. {This schedule {now modified principally by adjusting the interest rate} previously appeared in the Tax Clinic item, "Age Weighted Profit-Sharing vs. Target Benefit Plans," TTA, Aug. 1991, at 510.)

   This schedule assumes an 8.5% interest rate {rather than, the previous schedule's 7.5 %}for arriving at the PV factor. This higher interest rate causes a greater allocation to the o]der participants as a percentage of salary, and a lower allocation to the younger employees. For example, in allocation A, the three key employees enjoy an allocation of 76.4% of the total contribution using the 8.5% interest assumption {versus 73.0% at 7.5% ).

   The...