The New Comparability Gateway Test: 5% or One-Third Explained
Learn the new comparability gateway test, including the 5% or one-third concept and why precise testing matters.
The new comparability gateway generally asks whether each nonhighly compensated employee receives at least the lesser of 5% of compensation or one-third of the highest highly compensated employee allocation rate. The regulation’s details and exceptions need professional testing.
Choosing a profit-sharing allocation method is a plan-design decision, not merely a payroll calculation. An employer can decide whether to contribute in a year, including contributing nothing, but its written plan needs a formula for allocating any contribution.[1] That makes the method a practical promise to employees as well as a compliance input.
At a glance
- Core question: Does the formula match the employer’s benefit objective?
- Evidence: The written plan must state an allocation formula, and contributions may require annual nondiscrimination testing.[1]
- Reading path: define the formula, compare employee outcomes, then test the census.
Define gateway test
For this guide, an allocation formula is the rule that turns an employer contribution pool into participant accounts. The baseline questions are who is eligible, what compensation is counted, what allocation rate applies, and whether service or employment conditions appear in the document. A qualified plan must be operated according to its terms, and 401(k) designs also have separate rules around participation and employer contributions.[4]
The simplest uniform formulas can allocate the same percentage of compensation, the same dollar amount, or the same dollar amount per uniform unit of service. Those methods are specifically described in the defined-contribution nondiscrimination regulation’s safe-harbor framework.[2] A nonuniform design is not automatically improper; it simply needs an analysis appropriate to its structure.
Compare the decision lenses
| Lens | Question to ask | Why it matters |
|---|---|---|
| Business goal | Is the goal broad sharing, retention, or targeted retirement value? | The objective determines what “fair” means in this plan. |
| Employee census | How do compensation, age, service, and ownership groups differ? | Those facts can change testing and cost results. |
| Administration | Can payroll and the recordkeeper apply the rule consistently? | Document language and operation must agree.[4] |
Model the gateway with current compensation and rate data rather than relying on a rule-of-thumb. A useful comparison starts with contribution percentages and dollars, then asks whether those numbers are being evaluated as present allocations or as projected retirement benefits. That distinction is central to cross-tested approaches.[3]
What the comparison does not decide
A formula comparison does not decide whether a contribution is affordable, whether a participant is eligible, or whether an amendment is timely. Those are separate decisions with separate operational consequences. Keep the business objective, plan-document review, and test results in the same project file so the sponsor can explain why the selected method was chosen and how payroll will carry it out.
Editorial disclaimer: This educational article is not tax, legal, actuarial, investment, or compliance advice. Plan documents, controlled-group facts, and annual census data can change the analysis; consult the plan’s TPA, ERISA counsel, or qualified tax adviser before adopting or operating a formula.
Implement with a documented model
Start with a clean census and a written scenario. Identify eligible employees, compensation definitions, proposed allocation groups, employer contribution budget, and any safe-harbor or match contributions that interact with the design. Ask the TPA to model more than one reasonable contribution level; a formula that looks attractive at one level may produce a different result at another.
- Set scope: define the requirement, scope, timing, and decision owner.
- Check evidence: check documents, reports, controls, and open exceptions.
- Assign action: assign the approved action, deadline, and accountable owner.
- Revisit: revisit evidence, changes, and unresolved exposure.
Decision flow: define → compare → implement → review.
| Step | Owner | Output |
|---|---|---|
| Define | Employer and counsel | Objective, groups, and document terms |
| Compare | TPA or actuary | Current-census cost and testing illustration |
| Implement | Administrator and payroll | Adopted formula and allocation instructions |
| Review | Employer and advisers | Year-end test results and operation check |
Review the tradeoffs before year-end
Uniform percentage designs are often easier to explain because participants receive the same share of plan-year compensation. Publication 4806 describes that approach as the simplest and most common allocation formula.[1] A flat-dollar design instead makes the amount uniform, so its percentage-of-pay effect varies by employee. Cross-tested and age-sensitive designs add the possibility of evaluating allocations as equivalent benefits, which is why current ages and rate groups matter.[3]
Do not confuse an illustration with a guaranteed allocation. Regulations permit cross-testing under specified rules and also provide a general testing structure for nonuniform allocations.[2][3] When an employer uses permitted disparity, the defined-contribution rule requires conditions such as uniform disparity, an allowable integration level, and maximum disparity limits.[4] The provider should document the assumptions used, especially compensation, eligibility, and any related-plan information.
Practical questions for the adviser meeting
- Which employees are included or excluded under the document, and why?
- What contribution rate or dollar amount is assumed for each group?
- What tests are expected, and what changes would make the design fail or cost more?
- What timing, amendment, notice, and payroll steps are required before the allocation is made?
Planning resource
Takeaway
The new comparability gateway generally asks whether each nonhighly compensated employee receives at least the lesser of 5% of compensation or one-third of the highest highly compensated employee allocation rate. The regulation’s details and exceptions need professional testing. Treat the preferred method as a hypothesis until the plan’s actual census, document, and testing results confirm that it can be operated as intended.
Operational handoff
Before money is allocated, preserve the adopted design, eligibility roster, compensation data, and final calculation instructions. Reconcile the allocation file to payroll and participant records. If the proposed action differs from the document, pause rather than treating a past practice as an amendment. That discipline makes the year-end review more useful and gives the sponsor a clear record for participants and service providers.
Editorial disclaimer: Rules and document provisions can change. Obtain individualized tax, legal, actuarial, and compliance advice before relying on an allocation example or changing plan operations.
References
- [1] IRS and U.S. Department of Labor, Publication 4806, Profit Sharing Plans for Small Businesses. https://www.irs.gov/pub/irs-pdf/p4806.pdf
- [2] 26 CFR § 1.401(a)(4)-2, Nondiscrimination in amount of employer contributions under a defined contribution plan. https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR6f8c3724b50e44d/section-1.401%28a%29%284%29-2
- [3] 26 CFR § 1.401(a)(4)-8, Cross-testing. https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR0b03dc7813c7f4c/section-1.401(a)(4)-8
- [4] Internal Revenue Service, 401(k) plan overview. https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview