401(k) Profit Sharing Plan
Profit Sharing Plan Definition
Profit sharing plans are a special kind of retirement plan that allows employers to make contributions to employees' accounts based on the company's profitability. Many times, profit sharing plans are linked with 401(k) plans. Alone, profit sharing plans do not allow for employee contributions—all contributions are made by the employer—but when added to a traditional 401(k) plan, employees can also save their own money, giving them more control over their retirement savings strategy.
You don't need to have high profits to add profit sharing to your 401(k) plan. What it means is that you can add dollars to your and your employees' retirement accounts based on how your business does each year. This is purely discretionary and the amount can range from $0 up to whatever amount makes sense for your business.
Benefits of a Profit Sharing Plan
There are five main reasons why a business would want to pair a profit sharing plan with a 401(k):
Profit sharing plans are very flexible in terms of employer contributions.
By adding a profit sharing plan to a traditional 401(k), the business owner can save up to $57,000 per year (in 2020) in personal retirement savings.
Profit sharing is a feature that can be easily added to any 401(k) plan.
Contributions to a 401(k) plan with profit sharing are a deductible business expense and, earnings on the contributions grow tax-deferred for your employees.
Employees view a profit sharing contribution to their 401(k) as a employer dollars helping them achieve their retirement goals.
For small businesses, a 401(k) with profit sharing can help employers keep a firm grasp on how much they contribute, and to which employees. Traditional 401(k) plans with employer match usually require an employer to contribute to employees' retirement accounts consistently and at a standard rate. When you add profit sharing, however, you're able to decide each year how much you'd like to contribute based on how profitable your business is, giving you the power to manage your financial commitment when it comes to employer contributions
A 401(k) plan with profit sharing can be a valuable tool in helping your employees get ready for retirement, and also provide benefits to both employees and employers.
401(k) Profit Sharing and Vesting Schedule
Business owners can be concerned employees will leave the company and take their profit sharing dollars with them. If this is a concern, or if you want to use the profit sharing plan to help with employee retention, you can add a vesting schedule. A vesting schedule can allow your employees to vest all at once, say, after they've been with the company for three years, or over time, say 50% after the first year and 50% after the second year. You can set a schedule so that employees vest into their profit sharing contribution gradually over time.
A vesting schedule can be set up for a profit sharing plan, or any type of employer contribution. It allows you to determine when an employee qualifies to receive all of their employer contributions.
Profit Sharing Plan Contribution Limits
The simplest and most common profit sharing implementation is for the employer to contribute a flat dollar amount that is allocated based on a percentage of the employees' annual compensation. Total annual contributions limits are based on how much the employee defers, plus how much the employer contributes. The total amount contributed to the plan cannot exceed the lesser of:
- 100 percent of the participant’s compensation; or
- $57,000 for the 2020 tax year (for those 50 or over, an additional $6,500 is allowed as a catch-up contribution)
Types of 401(k) Profit Sharing Plans
There are four types of Profit Sharing Plans you can add to your 401(k).
Pro-Rata: Employees get the same amount, determined by the employer each year. The amount is based on a percent of salary.
Integrated: Allow an employer to contribute different amounts to employees based on their Social Security tax levels.
Age-Weighted: The contribution amount is determined based on the age of the employee, and older employees receive more.
Flexible: Cross-testing allows you to create multiple benefit groups with their own contribution rates.
Will Profit Sharing Work for Your Business?
Schedule a call with one of our profit sharing plan specialists today.