Whether you’re a non-profit organization or small business, there’s opportunity to offer profit-sharing plans to employees, even if you already offer another type of retirement plan. A profit-sharing retirement plan is a plan designed to give employees a share in their company’s profit based on earnings.
This plan is available to all sizes of companies and flexible in design. One of the most notable features of a profit-sharing plan is the ability to have varying contribution amounts to the plan each year. Having flexibility in contribution amounts makes profit sharing an attractive option for businesses whose cash flow may not be consistent year-to-year.
Profit-sharing retirement plans offer several benefits to an employer with minimal restrictions; however, the IRS does require profit-sharing plans to have a set formula that will determine how the contributions are divided between each employees’ accounts.
Participation, Contributions and Vesting
Profit-sharing plan participation:
In general, a plan must be offered to all employees. There are a few exceptions to this requirement such as being under 21 years of age, time-worked, etc.
Profit-sharing contribution rules and limits:
A company doesn’t have to be profitable to offer (and contribute) to a profit-sharing plan. Typically, a plan will base contributions on profit, but that doesn’t have to be the case due to the minimal contribution restrictions. For most plans, contributions are made by the employer. The plan would need to include a 401(k) cash or salary deferral feature to allow for employee contributions.
The per-participant annual employer contribution limit is the lesser of:
-100% of participants compensation, or
– $66,000 for 2023 ($61,000 for 2022; $58,000 for 2021)
Profit-sharing vesting options:
Lastly, an employer can choose for funds contributed to employees to be vested over a period of time (according to a vesting schedule), or funds maybe be fully vested immediately. If there is a 2-year waiting period to participate in a company profit-sharing plan, funds will be fully vested at the time of contribution.
Benefits of Profit-Sharing Plans for Employers (and the Cons)
Pros:
Substantial tax benefits – If an employer contributes to a profit-sharing plan, they can deduct 25% of the compensation paid during the taxable year to all participants.
Aid in employee recruitment and retention – It’s an attractive benefit that current and prospective employees may appreciate – especially if offered in conjunction with a regular 401(k) plan. Profit-sharing provides an avenue for an employer to make larger contributions to an employee’s retirement plan, helping the employee build savings for their future.
Plan design is flexible – Contributions can be changed year-to-year if needed based on business income.
Cons:
Form 5500 requirement – Employer will need to file a Form 5500 annually.
Summary Plan Description (SPD) requirement – A SPD explains the plan and participants rights and responsibilities. When a participant enrolls in the plan, the SPD must be given to the participant. The SPD must also be given out periodically while the company has an active plan profit-sharing plan.
Discrimination testing – Required to ensure HCEs are not being favored.
Cost – Profit-sharing plans increase compliance workload which can lead to heightened administrative costs. For some businesses, the tax-savings outweighs the administrative costs and makes profit-sharing the wise choice.
Retirement Plan Consultants can create a plan cost comparison to show how profit-sharing may benefit a business. Click here to request a proposal.
Benefits of Profit-Sharing Plans for Employees (and the Cons)
Pros:
Not part of taxable income – Profit-sharing contributions added to retirement accounts do not increase taxable income.
Can still contribute to another retirement plan – The employer contributions do not count towards an individual’s 401(k) contribution limit.
Higher employer contribution limits – Plans have higher employer contributing limits compared to traditional retirement plans, allowing for the potential to put more money in employees’ pockets.
Cons:
Employer may choose not to contribute – An employer is not required to contribute anything. If the only plan offered to an employee is a profit-sharing plan, it may be wise move to open another account to save for retirement.
Types of Plans
- Stand-alone plans that only have employer profit-sharing contributions
- Plans that are combined with, and part of, a 401(k) plan, to allow for employee contributions
Since a profit-sharing plan is a qualified retirement plan, it must comply with the ERISA rules, whether stand-alone or combined with another plan. Your retirement plan provider can walk you through the plan design discretions, set parameters and provide service to ensure the plans follow compliance.
Before a company can offer a profit-sharing plan, there are a few items to consider:
- Hire Retirement Plan Consultants to help set up the plan
- Decide what features the plan will offer
- Notify eligible employees and provide information for decision-making
- Set up a trust for the plan or set up plan with insurance contracts
- Confirm recordkeeping services with Retirement Plan Consultants
- Decide on annual employee contributions
- Gain understanding of companies fiduciary responsibilities (RPC can help with this!)
- Adopt a plan to monitor the plan’s service providers
- Finally, gain understanding of the reporting and disclosure requirements of the profit-sharing plan
Set up a 401(k) with a Profit-Sharing Plan Now
Retirement Plan Consultants (RPC) is ready to help set up a profit-sharing retirement plan or incorporate a profit-sharing feature into an existing plan. The current timing is ideal for establishing a profit-sharing 401(k) as the SECURE 2.0 Act provides added benefits in addition to the usual tax savings of a profit-sharing plan. To initiate a profit-sharing retirement plan, contact the experts at Retirement Plan Consultants today!