What is cross-testing in the context of retirement plans?

Cross-testing is a strategy utilized in defined contribution plans, such as profit-sharing plans, to ensure compliance with nondiscrimination testing requirements. This testing is crucial in retirement plans, as it helps demonstrate that the plan does not disproportionately favor highly compensated employees over lower-paid employees. By using cross-testing, employers can evaluate the benefits provided to different employee groups in a manner that can account for differences in contributions and earnings.

In this process, the employer calculates the benefits that participants would receive at retirement age and compares these across different classifications of employees. The results permit the employer to establish that benefit distributions are equitable across the workforce, thereby satisfying the Internal Revenue Service's (IRS) nondiscrimination standards. This is particularly relevant in situations where plans may offer different levels of benefits to various employee categories.

Cross-testing is distinct from evaluating employee performance, determining eligibility for profit-sharing, or assessing employee satisfaction, as it specifically targets the compliance aspect of retirement plan structures and their equitable distribution of benefits among employees.