Profit sharing is a way for an employer to contribute some of the company profits to employees. Employers commonly combine Profit Sharing with an employer-sponsored retirement plan, like a 401k.

Profit Sharing plans have different formulas to determine contribution amounts. They are Subject to IRS limits, the actual contribution is determined by a formula specified in the plan document.

We are happy to run a calculation for you. Book a consultation.

There are three primary types of profit sharing plans: the pro-rata plan (the most common), new comparability plans (the most flexible), and age-weighted plans (most helpful for retaining talent). By thinking about profit sharing contributions in terms of employee age, importance to your company, and your business goals, you can choose the one that will work best for your business. Here are the details of each:

A PRO-RATA PLAN: A pro-rata plan is one where everybody in the plan receives employer contributions equally. It works similarly to an employer match, in that every employee receives the same percentage of their compensation as an employer contribution. For employers who want simplicity, but are interested in adding an additional benefit, this is a great choice.

NEW COMPARABILITY 401(K) PROFIT SHARING: New comparability profit sharing (aka “cross-testing”) offers the most flexibility for owners who want to personally receive the maximum possible contribution or who want to be able to make contributions to employees at different rates. By placing employees into separate benefit groups, owners can get the maximum percentage contribution while other employees get a smaller amount. In our experience, cross-testing works best with older owners and a younger employee base.

AGE-WEIGHTED PROFIT SHARING PLANS: Our clients use age-weighted Profit Sharing plans when the older an employee is, the higher percentage contribution they’ll receive. This is a good option for employers primarily concerned with retaining talent; the longer someone stays with the company, the more their employer contribution rate will increase.

• Save More for Retirement: Employees like Profit Sharing because their employer is contributing money to their retirement. It’s free money! Many employees in America know they are underprepared for retirement. In fact, 46% of American workers not yet in retirement believe they will not have enough money saved to maintain a comfortable lifestyle when they do retire.2 A 401(k) plan of any kind gives them an employer-sponsored way to easily save and invest in order to maintain their standard of living in retirement, especially when it’s backed by the educational support employees need to make good saving decisions.
• Get Rewarded for Hard Work: Employees know their work can make all the difference in helping their employers reach profitability. By sharing your profits with your employees with a Profit Sharing 401(k) plan, you are giving them a direct incentive to work harder and keep the company growing and thriving.

401(k) plans often offer Profit Sharing because they provide complementary benefits to the business.

• A 401(k) plan allows employees to save their own money into the plan.
• A Profit Sharing plan allows employers to contribute to employee accounts—but employees cannot make their own contributions with a Profit Sharing plan alone.
• Combining the two allows for both employee and employer contributions, creates flexibility for employee bonus structures, and allows the business owner to save more

Keep in mind that there are pros and cons to adding a Profit Sharing plan to your 401(k).

• If your profitability fluctuates from year to year this could make it tough on morale if employees get a lower compensation than expected. Let’s review these and any other drawbacks and figure out if the advantages of Profit Sharing outweigh the disadvantages for your business.

A 401(k) plan with profit sharing adds an extra feature that allows an employer to make pre-tax contributions to their employee’s 401(k) retirement accounts based on their profits.

Unlike a 401(k) with “employer match” (for example, a Safe Harbor match), which requires employers to match employee savings up to a certain percentage of their salary, profit sharing allows an employer the flexibility to choose how much money to contribute each year. The match can even be discretionary.

The 401(k) portion of the plan is in many ways just like any other 401(k) plan:

• Employees can contribute.
• Contributions can be either pre-tax or after-tax (Roth 401k).
• Contributions can be invested into mutual funds such as money market funds, bond funds, and mutual funds for the purposes of growing over time to help the employee save for retirement.

Businesses have different needs and goals but if you’re looking for ways to :

1. Retain your best employees.
2. Reduce federal and state tax liability
   

then a Profit Sharing plan might be the solution.

• Control Contribution Amounts: The amount you contribute is completely up to you, so you have the ability to do what makes the most sense for your business. You can also divide employees into distinct eligibility groups, giving you the flexibility to contribute at different rates for different sets of employees based on a pre-determined allocation formula.
• Attract and Retain Talent: As of 2016, the average employer contribution in a Profit Sharing plan is 4.7% of an employee’s salary.1 Using this as a baseline, you can choose to give certain employee groups a higher contribution rate in order to attract and retain top talent. Additionally, just like with a traditional small business 401(k) plan, you can set up your vesting schedule to determine how long an employee must work for your company before they own 100% of the Profit Sharing contributions you make.
• Lower Tax Liability: As with other types of 401(k) plans, all your contributions to a 401(k) plan with Profit Sharing plan are tax-deductible. However, if you’re looking to lower your small business’ taxable income in more profitable years, profit sharing 401(k) plans can help you make the highest possible contributions to get the highest possible write-off. That’s because these plans have a much higher maximum employer contribution limit.

This is not a complete list but here are some highlights to keep in mind:

• 401(k) plans with profit sharing have rules for maximum contributions, tax deduction limits, reporting, and timing.
• Total Contribution Limits: Changes annually with new IRS Guidelines. We can discuss this during our consultation.
• Calculation Rules: Changes annually. We will calculate this for you.
• Tax Deduction Limits: Employers can deduct Profit Sharing contributions from their taxes up to maximum contribution limits.
• Disclosures and Forms: As with many other 401(k) plans, employers are required to issue disclosures to employees and anyone else who participates in a 401(k) Profit Sharing plan. Additionally, the form 5500 must be filed with the Department of Labor annually. This is prepared by our administration team for your review.
• Funding Deadline: All employer contributions to a Profit Sharing plan have an annual funding deadline of April 15 (unless an extension is filed).

Setting up a Profit Sharing plan as part of your 401(k) can be as easy as adding an amendment to your plan document, but a good Profit Sharing plan requires some planning. The best Profit Sharing plans align with a company’s goals and this makes Profit Sharing and 401(k) plan administration easier as the years go on.