Three Tips for Managing 401(k) Profit Sharing Contributions
posted by Alex Queen May 30, 2017
One of my goals as a Retirement Counselor with Fisher Investments 401(k) Solutions is to make managing retirement plans easier for my clients. I spend my time speaking with a lot of business owners, answering their questions about 401(k)s and profit sharing plans. When you’ve been doing it as long as I have, you start to see patterns develop and common questions come.
In the spring, many of the questions I get from clients with 401(k) or profit sharing plans have to do with employer contributions, which are the dollars employers can put into an employee’s retirement account based on a formula written into the plan’s governing plan document. With contribution funding deadlines for some companies falling in March and others in September, many employers with profit sharing plans begin asking some very good questions:
- How do profit sharing contributions work?
- What choices do I have for them?
- How can I contribute more to this person or group versus that person or group?
- How can I get up to the $54,000 IRS contribution maximum?
Like many aspects of retirement plan management, profit sharing contributions can be complicated, but they can also be manageable—if you understand how the process works. While every case is different, I believe there are three main ideas to keep in mind when thinking about profit sharing contributions.
1. Make sure your plan design aligns with your goals for profit sharing contributions.
Plan design touches on things like eligibility, distributions and loans, and also the way contributions are handled. The best plan designs I’ve seen are aligned well with my clients’ goals. I generally see three different contribution goals:
- They’re using profit sharing and additional match contributions as an incentive to boost employee participation in the plan.
- They’re seeking to make a maximum contribution to a key group of employees—maybe board members or executives.
- They have a particular dollar amount in mind that they’d like to contribute to their employees’ retirement accounts, and want to allocate that money in a specific way.
The decisions you make when it comes to plan design have a significant impact on the freedom you have in handling your contributions down the line. For example, I recently worked with a medical practice whose plan document divided their participants into three groups for determining the size of profit sharing contributions:
1) Members of the corporate board
2) Family members of the corporate board
3) General employee base
An issue arose when a new doctor was hired, and the medical practice planned to put the doctor on the board. In the meantime, since only three “rate groups” existed, the doctor—by default—was placed in the general employee base group, and therefore did not qualify to receive the maximum contribution that board members received. In this example, one solution would have been to use individual rate groups in their plan design, so that each participant is seen as their own rate group. And while that might be pretty specific to this case, I encourage any employer to really take some time and think about their goals for their employees. You might not be able to predict every change that will come as your company grows and evolves, but I know that the easiest way to plan for the future is to build plenty of flexibility into your plan today. That way, when you run into scenarios like this one, it’ll be much easier to make the contributions you want to make possible.
2. Maintain accurate employee census data.
In a previous article, I shared some tips for surviving 401(k) compliance testing season. Compliance testing can be frustrating, no doubt, but if you’ve gone through compliance testing recently, you can enjoy the benefits of the clean employee data your provider helped you to organize. When I talk about employee census data, I mean the basic information about your employees—hiring dates, termination dates, compensation—needed to determine retirement plan eligibility throughout the year. One of the most important things I do in the spring is review client data, and point out inconsistencies or other issues I find, so we can work on getting the data right.
When it comes to getting an accurate profit sharing calculation, using good, clean data is a must. I’m reminded of a client who learned the value of good data firsthand when they added a 401(k) to their profit sharing plan. This employer had a fairly large headcount, so they had a lot of employee data census to handle. In the past, this was never an issue; they did not process contributions with payroll every other week with their profit sharing only plan. When compliance testing season came around, it was a big learning experience; the data didn’t look like it had been managed well and there was a lot of work to do to go through that data, find the causes of any issues, and make corrections.
The big takeaway here is this: don’t let bad data pile up. Contribution calculations are like any other equation; if you put garbage in, you get garbage out. But here’s the good news: You don’t have to come into this knowing everything there is to know about maintaining good data. A trustworthy service provider will be able to encourage and educate you on good data management practices, which in turn will make your life much easier when it comes time to fund your profit sharing contributions.
3. Keep on top of your contribution funding deadlines.
One of the most important benefits of a retirement plan is the way it can help both employees and employers hold onto more money for retirement. There are some pretty strict deadlines when it comes to funding profit sharing contributions in profit sharing plans, and they have to be met in order for those contributions to remain tax-deductible. When I say “funding,” I mean that the money must be received by the trust company holding your retirement plan’s assets by that deadline. That money doesn’t necessarily need to be allocated to the participants’ accounts by then, as that can take a few days to process. Most employers operating on a calendar year basis have a default funding deadline of March 15th, but many companies choose to extend that deadline, and wind up with a final funding deadline of September 15th.
One of the best ways to keep your profit sharing contributions manageable is to request a calculation from your provider well ahead of your deadline. The more time you have to get your data right and understand exactly how much money you need to contribute, the easier it will be to cross your T’s and dot your I’s. For those who stick with the March 15th date, send the request over first thing in January. Even for those who extend to the September 15th deadline, it’s important to get the process started early in the new year. Employers might consider getting an estimate of your contribution in December, when your data for the year is mostly complete and you can get at least a good idea of what you’ll be paying. This is helpful for a few reasons. First, it’ll help with cash flow if you need time to get your contribution dollars together. Second, it can also help you estimate your taxes and see what you’ll be able to deduct. Ultimately, this estimation can help you plan better, which is always a good thing.
That’s what this all comes down to in the end: planning. Contributions are a topic that will come up every year for profit sharing plan managers, but planning well when it comes to plan design, data management, and deadlines will make sure your experience in offering profit sharing contributions is a good one.