3863 / What is permitted disparity and how does it work?

Permitted disparity, also called Social Security integration, describes a contribution allocation formula or a benefit accrual formula that has two tiers of benefits. Under this formula, higher paid participants receive a slightly larger employer-provided benefit than employees whose contribution is below a level specified in the plan (i.e., the integration level in a defined contribution plan).

Permitted disparity rules are an exception to the general nondiscrimination requirement. Thus, a plan may use permitted disparity and still be classified as a safe-harbor design. The two-tier formula is based on the principle that employer-paid Social Security benefits will fund a greater portion of the replacement income of lower paid workers than of those whose earnings are above the Social Security wage base. The rules for permitted disparity are found under IRC Section 401(l).

An integrated plan will not be considered discriminatory merely because plan contributions or benefits favor the highly compensated employees if certain disparity thresholds are met.¹ If the requirements of IRC Section 401(l) are met, the disparity will be disregarded in determining whether the plan satisfies the nondiscrimination rules ( Q 3848).² The regulations under IRC Section 401(l) provide the exclusive means for a plan to satisfy IRC Sections 401(l) and 401(a)(5)(C).³