Retirement Plans for Manufacturers: 401(k), Cash Balance, and Cross-Tested Plans for a Mixed Workforce

Manufacturing businesses face a retirement plan design problem that most professional services firms and tech companies do not. The workforce is split: a small number of highly compensated owners and managers want to defer as much income as possible into tax-advantaged retirement accounts, while a larger group of production workers, warehouse staff, and line supervisors earns lower wages, has less capacity to contribute, and turns over at a higher rate than the white-collar workforce. A standard 401(k) plan will either fail the nondiscrimination tests (because the highly compensated employees defer at much higher rates than the rank and file), require employer contributions that flow disproportionately to the lower-paid group, or both. The solution is a plan design that satisfies the nondiscrimination requirements while directing the maximum allowable benefit to the owners, and several structures accomplish this under IRC 401(a).

Why does a standard 401(k) fail for manufacturers?

A 401(k) plan must satisfy the Actual Deferral Percentage (ADP) test under IRC 401(k)(3) and, if the plan has matching contributions, the Actual Contribution Percentage (ACP) test under IRC 401(m). These tests compare the average deferral and contribution rates of highly compensated employees (HCEs, defined as owners with more than 5% ownership or employees earning above $155,000 in the prior year for 2025) with those of non-highly compensated employees (NHCEs).

The ADP test requires that the average deferral percentage of HCEs not exceed the average deferral percentage of NHCEs by more than a specified margin. If NHCEs defer an average of 3% of compensation, HCEs can defer no more than 5% (under the 2x/2% rule) or 8% (under the 1.25x rule), depending on which test the plan applies. In a manufacturing company where the owners want to defer the maximum $23,500 (roughly 10-15% of a $200,000 salary) but production workers earning $40,000 defer only 2-3%, the test fails. The owners’ deferrals are refunded (a “corrective distribution”), which defeats the purpose of the plan.

This failure pattern is predictable in manufacturing because of the compensation gap between owners and production workers, the lower participation rates among lower-paid employees, and the higher turnover in production roles (employees who leave before the enrollment period or before they are eligible do not contribute to the NHCE average, dragging it down further).

How does a Safe Harbor 401(k) solve the testing problem?

A Safe Harbor 401(k) eliminates the ADP and ACP tests entirely by committing the employer to one of two contribution formulas: a 3% nonelective contribution to all eligible employees (regardless of whether they defer), or a matching contribution of 100% on the first 3% of compensation deferred plus 50% on the next 2% (effectively a 4% match for employees who defer at least 5%).

The benefit is certainty. Once the Safe Harbor contribution is made, the owners can defer the full $23,500 (plus catch-up contributions) without any risk of a failed ADP test or corrective distributions.

The cost is the mandatory employer contribution. For a manufacturer with 50 production employees averaging $45,000 in compensation, the 3% nonelective Safe Harbor costs $67,500 per year ($45,000 x 3% x 50). That $67,500 is fully deductible as a business expense under IRC 404, and it vests immediately (Safe Harbor contributions must be 100% vested). The matching formula can be cheaper if participation is low (the match is only paid to employees who defer), but the match also creates an incentive for higher NHCE participation, which may increase the cost over time.

For manufacturers, the 3% nonelective is often preferred because it provides a predictable cost regardless of employee behavior, it counts as an employer contribution for purposes of the cross-tested profit sharing allocation (discussed below), and it does not require the employer to track and match individual employee deferrals.

What’s a cross-tested profit sharing plan?

A cross-tested (also called “new comparability”) profit sharing plan allows the employer to allocate profit sharing contributions at different rates to different groups of employees, as long as the allocation satisfies nondiscrimination testing on a cross-tested basis. Cross-testing evaluates the allocation by converting each participant’s contribution into an equivalent benefit (a projected annuity at retirement age), which allows the plan to pass testing even though the dollar contributions to the owner group are proportionally much larger than those to the employee group.

The cross-tested plan is the workhorse of small-to-mid-size manufacturer retirement planning because it respects the nondiscrimination rules while channeling contributions toward the owners in a way that a pro-rata plan cannot.

When does a cash balance plan suit manufacturers?

A cash balance plan is a defined benefit plan that looks like a defined contribution plan to participants (each participant has a hypothetical “account balance” that grows by an annual pay credit and an interest credit), but is funded and deducted as a defined benefit plan, which means the contribution limits are much higher. Under IRC 415(b), the maximum annual benefit from a defined benefit plan is $280,000 per year (2025 limit) payable as a life annuity at age 62. The contribution required to fund that benefit depends on the participant’s age: an older participant closer to retirement needs a larger annual contribution to reach the benefit target.

For a 55-year-old manufacturing company owner, the annual contribution to a cash balance plan can exceed $275,000. Combined with the 401(k) deferral and cross-tested profit sharing, the total annual tax-deferred contribution can reach $350,000 or more. The entire contribution is deductible by the business.

The cost for employees in a cash balance plan is a fixed pay credit (often 3-5% of compensation), which produces a predictable annual cost. For 40 employees at $45,000 average salary with a 3% pay credit, the employee cost is $54,000 per year, plus the actuarial and administrative fees for the plan ($3,000 to $5,000 annually).

Cash balance plans are most attractive for manufacturing owners over age 45 with consistent income of $300,000 or more who want to defer significantly more than the 401(k) and profit sharing limits allow. The plan requires a multi-year commitment (defined benefit plans carry funding obligations that are not easily unwound), so it is best suited for stable, profitable manufacturers rather than companies with volatile earnings.

What SECURE 2.0 provisions affect manufacturers?

The SECURE 2.0 Act introduced several provisions relevant to manufacturing employers.

Automatic enrollment is mandatory for new 401(k) plans established after December 29, 2022 (with exceptions for businesses with 10 or fewer employees, businesses less than three years old, church plans, and governmental plans). New plans must auto-enroll eligible employees at a deferral rate of at least 3% (but not more than 10%), escalating by 1% per year to at least 10% (but not more than 15%). For manufacturers establishing a new plan, this is not optional. Existing plans are grandfathered.

The starter 401(k) is a new simplified plan option for employers that do not currently sponsor a retirement plan. It has low contribution limits ($6,000 employee deferral, $1,000 catch-up) and no employer contribution requirement, but it also has no nondiscrimination testing. For small manufacturers who have avoided sponsoring a plan because of the testing complexity and employer contribution cost, the starter 401(k) is an entry point, though the contribution limits are too low to be useful for owners seeking significant tax deferral.

Enhanced tax credits for small employers (under 50 employees) offset the cost of starting and maintaining a plan. The credit covers 100% of administrative costs up to $5,000 per year for the first three years (for employers with 1-50 employees), plus an additional credit for employer contributions of up to $1,000 per employee for the first five years. For a manufacturer with 30 employees starting a new Safe Harbor 401(k), the credits can offset much of the employer contribution cost in the early years.

The “super catch-up” contribution for participants ages 60-63 allows deferrals of $11,250 (instead of the standard $7,500 catch-up), effective for tax years beginning after December 31, 2024. For manufacturing owners in this age window, the additional deferral capacity is meaningful.

How does employee turnover affect plan design?

Manufacturing has higher employee turnover than most white-collar industries, particularly among production and warehouse workers. Turnover affects retirement plan economics in two ways.

First, employer contributions for employees who leave before vesting are forfeited back to the plan. Safe Harbor contributions must vest immediately, but profit sharing and cash balance contributions can use a vesting schedule of up to six years (graded) or three years (cliff). In a manufacturer with 30% annual turnover among production workers, a significant portion of employer profit sharing contributions are forfeited each year, which reduces the net cost of the plan. Forfeitures can be used to reduce future employer contributions or to pay plan expenses.

Second, turnover creates administrative burden: new employees must be enrolled (automatically, under SECURE 2.0 for new plans), terminated employees must receive distribution notices, and the census data for nondiscrimination testing changes constantly. A third-party administrator (TPA) handles this, but the administrative fees are higher for plans with frequent turnover than for stable workforces.

The plan design should account for turnover explicitly. A vesting schedule on profit sharing contributions (six-year graded is common) ensures that short-tenure employees forfeit most or all of the employer’s contribution, which effectively redirects those dollars to long-term employees and to the owner through reduced future contributions. The Safe Harbor contribution (which cannot vest) is a sunk cost for every eligible employee, but at 3% of compensation, the per-employee cost is modest.

What should I do next?

Retirement plan design for manufacturers sits at the intersection of tax planning and workforce management. The same owners who benefit from a cash balance plan are likely evaluating cost segregation on their facility, export incentives on their international sales, sales tax exemptions on their equipment purchases, and workers’ compensation strategies for their production workforce.

• Cost segregation for manufacturing facilities, reclassifying building components for accelerated depreciation
• Sales and use tax exemptions, state-level exemptions for machinery, raw materials, and utilities
• International tax and export incentives, IC-DISC, FDII, and transfer pricing
• Workers’ compensation and safety deductions, deductibility of premiums, OSHA compliance, and self-insured reserves
• Law firm retirement plans, a parallel industry-specific guide covering Solo 401(k) and defined benefit for small professional firms

Related guides:

• Manufacturing Cost Segregation Facility
• Manufacturing Entity Structure Llc Scorp C Corp
• Manufacturing Equipment Depreciation Section 179
• Manufacturing International Tax Export Incentives
• Manufacturing Inventory Accounting Unicap 263A

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.