401(k) Profit Sharing
With a profit sharing plan, employers make contributions to employee accounts in accordance with the company’s profitability. These are often linked to 401(k) plans because, on their own, profit sharing plans do not allow for employee contributions into their own accounts—all contributions must be made by the employer. However, when coupled with a traditional 401(k) structure, employees can make their own contributions as well, meaning they also have more control over the investment choices in their accounts.
The amount that an employer makes as a profit sharing contribution is up to the discretion of the company and can range from $0 to any amount the company deems appropriate for any particular time frame. This flexibility is a benefit to small companies especially, as they can judge each year what is the best amount to contribute, as opposed to traditional 401(k) plans with an employer match where the match must be made at a standard rate consistently. As with any contributions to a 401(k), these contributions are tax-deductible for the company and tax-deferred for the employees.
When determining the contribution amount, as stated above, it is up to the employer. The most common method, however, is for the employer to contribute a flat dollar amount that is then allocated on a percentage of employees’ annual salaries. There are established limits on how much total the employer can contribute; the amount cannot exceed the lesser of either 100% of the participants’ compensation or $57,000 (for the 2020 tax year, however, for employees 50 or over, an additional $6500 catch-up contribution is allowed). An employer can set up a vesting schedule within the program to determine the rate at which employer contributions belong to the employee, which can help with employee retention. The schedule can be set up however the employer chooses, whether it is a certain percentages over time the longer the employee remains with the company or all at once after a set number of years.
This feature is easily added to any traditional 401(k) plan, and employees of course appreciate employer money helping them with their own personal retirement goals.
There are four types of profit sharing plans that can be added:
- Pro-Rata: All employee accounts receive the same amount, based on a percentage of salary, every year, with the amount determined by the employer.
- Age-Weighted: The age of employees is taken into consideration, with older employees being given a larger allocation of the contribution.
- Integrated: Employees receive different amounts of employer contributions based on their Social Security tax levels.
- Flexible: Employers set up multiple benefit groups with their own contribution rates for the employees in each one.
All of these types provide different benefits to the employer and employees, and the employer can choose which best suits their own company.
