Small Business Owners: Maximize Your Retirement Savings Using a 401(k) Profit Sharing Plan

If you’re a business owner looking to maximize your retirement savings, a 401(k) alone may not be enough to create the nest egg you want. However, there are additional features that can be added to your company 401(k) that can increase your 401(k) contribution limits—and make it easier to reward your employees. Read our guide to find out how to boost your retirement savings using a simple 401(k) profit sharing method.

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The term “profit sharing” can refer to several different concepts, but in this context, we’re talking about a component that can be added to a 401(k) plan that allows an employer to make flexible annual contributions for themselves and their employees.

What is a 401(k) Profit Sharing Plan?

If an employer would like to retain the freedom to choose how much they contribute to their employees' retirement accounts depending on the profits the business sees in a given year, then a profit-sharing plan is a good choice. A standard 401(k) with employer match requires employers to set a standard rate—maybe it’s 3% of an employee’s salary—at which they will match the dollars employees choose to save. With a profit sharing plan, the employer is not committed to a contribution rate in the same way.

What are the advantages of profit sharing over a standard employer match?

Flexible contribution rates: A 401(k) with profit sharing offers a lot of flexibility when it comes to employer contributions. Contributions are made on an annual basis (as opposed to a standard employer match, which happens each pay period), and the employer has the ability to determine how much they’d like to contribute each year. There’s even flexibility when it comes to determining how much to give different employees, but more on that later.


Increased contribution potential: Adding profit-sharing to a 401(k) allows individuals to contribute up to the annual limits, which are currently $61,000. How? Each individual is only allowed to save up to currently $20,500 of their pre-tax income in their personal 401(k) account. However, employer contributions (like profit sharing) don't count toward that amount, and employers are allowed to contribute more than individuals. Profit-sharing means that when times are good, everyone can benefit.


Several types of Profit Sharing:

Not all profit sharing plans are cut from the same cloth. There are four different ways to implement and manage profit sharing in a 401(k) plan.


All employees treated the same:

In the most common setup, called "pro-rata," all employees receive the same contribution rate, which employers determine each year, in terms of a percentage of their salary.


Integrated with social security:

"Integrated" profit sharing plans allow an employer to contribute different amounts to employees based on their Social Security tax levels.



Determined by employee age:

Some profit sharing plans, known as “age-weighted” plans, equate contributions to equivalent benefits at retirement age, which means older employees will receive a higher contribution rate.



Sometimes referred to as “New Comparability” profit sharing, cross-testing allows employers to create separate benefit groups with their own contribution rates. In other words, different groups of employees receive different contributions. This is the type of plan covered by this white paper.

Cross-tested Profit Sharing at Work in a 401(k)

Cross-testing allows owners of small and growing businesses to offer benefits to all employees without compromising retirement security.

Many small business owners start 401(k) plans with profit sharing to benefit their hard-working employees. Sometimes, however, a basic 401(k) plan with profit sharing that treats every employee the same—including the owner—can make it challenging for the owner to stay on track for retirement.

Cross-testing at Work: Take, for example, a dentist who owns a small practice with five employees. Her pro-rata 401(k) plan with profit sharing offers every employee a 5% contribution from the company each year. This is a valuable benefit but it only ever allows the dentist to give herself an employer contribution of $13,000 per year and pass compliance tests. At age 55, the dentist would need to save more in order to maintain her standard of living in retirement.

By making a simple amendment to the practices’ 401(k) plan document, the profit sharing can be changed from a pro-rata plan to a cross-tested plan, which grants the dentist the flexibility to place herself into a different benefit group than the rest of her employees. With this one change, the dentist can increase the employer contributions to her own account to $36,000 per year without increasing contribution rates for her employees. The additional $22,000 per year to save and invest will make all the difference in keeping the dentist on track for her retirement.

Cross-testing At Work: Helping Business Owners Save More

With a pro-rata profit sharing plan, the dentist is limited to $13,500 per year in 401(k) employer contributions for herself. Cross-testing reveals she could make $36,000 in employer contributions to her account—without changing her contributions to other employees.

Dentist 55 $270,000 5% $13,500 13.33% $36,000
Employee 1 50 $40,000 5% $2,000 5% $2,000
Employee 2 45 $35,000 5% $1,750 5% $1,750
Employee 3 35 $35,000 5% $1,750 5% $1,750
Employee 4 30 $35,000 5% $1,750 5% $1,750
Employee 5 30 $35,000 5% $1,750 5% $1,750
Increased contribution to owner $22,500
Increased contribution to employee 0

Is a Cross-tested 401(k) Profit Sharing Plan Right For Your Business?

The dentist’s story is one example of a good cross-testing fit. Who else could benefit from cross-testing?

1Small businesses: Since cross testing works best with a ratio of no more than 25 employees for every one owner, businesses with small teams are ideal—especially when the owner wants to save more for retirement, but also wants to take care of their small team.

2Small professional services firms: Since cross testing works best with a ratio of no more than 25 employees for every one owner, businesses with small teams are ideal—especially when the owner wants to save more for retirement, but also wants to take care of their small team.

3Growing companies: Some small companies start with 401(k) plans that feature pro-rata profit sharing, but find it expensive to continue offering a flat contribution rate with each new hire. It’s an easy transition for these companies to switch to cross-testing, allowing them to contribute to new employees at different rates and control costs.

Best practices for setting up a 401(k) profit sharing plan with cross-testing

If your business seems like a good fit for a cross-tested plan, there are some best practices you can follow to make sure cross-testing goes off without a hitch:

  • Make ideal contributions to “Non-Highly-Compensated Employees” (NHCEs): The IRS defines “Highly-Compensated Employees” as anyone who owns 5% of the interest in a business or makes more than $130,000 per year.1 The term “NHCE” refers to any other employee. As a general rule, cross-tested plans successfully pass these tests when NHCEs are given a minimum contribution of 5% or one-third the rate of HCEs. Each situation is unique, but for the dentist, the ideal balance that would allow her to increase her own total contributions while passing tests was 5% for NHCEs and 13.33% for her.
  • Make more money and be older than NHCEs: Because cross-testing looks at the benefit to each employee at the time of retirement, these plans generally work best when an owner makes more money than their NHCEs and is also older.

Starting a Cross-tested 401(k) Profit Sharing Plan for Your Business

Under the right circumstances, the process of cross-testing a 401(k) plan with profit sharing can have a big impact:

  • Profit sharing increases the owner's annual contribution limit from $20,500 to $61,000 currently.
  • Cross-testing allows owners to increase their contributions without increasing contributions to their employees.
  • Cross-testing offers even more flexibility than a pro-rata 401(k) with profit sharing.

If cross-testing sounds like the right fit for your profit sharing plan, or you think you might want to add a profit sharing component to your existing 401(k), know your profit sharing schedule—changes like this should be made by November to take effect the next year. If you want to adopt this provision to an existing 401(k) with profit sharing, all it takes is a simple plan amendment.


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