401(k) Profit-Sharing Plan

• Profit-sharing is typically offered as a 401(k) plan feature.
• Employees do not have to make contributions to their own plans, though adding a salary deferral option would convert the plan into a 401(k).
• Unlike a Safe Harbor 401(k), employers are not mandated to make contributions every year and the profit share can be subject to a vesting schedule (up to a three-year cliff or six-year graded).
• Employees can take out loans from their profit-sharing plans or roll over the money into an IRA when leaving the company. Like a 401(k), distributions taken before age 59.5 are subject to a 10% penalty.

Employers like profit-sharing plans because:

They can better control 401(k) costs.

• The flexible contributions are an excellent choice for start-ups, erratic industries, or companies that frequently acquire other businesses. Many employers like having the ability to do what makes sense from year to year without being locked into a potentially costly formula. Employers that are set up as S Corps or Partnerships have until the March 2023 tax filing deadline to decide on their contributions unless extended until September, while deducting them on the 2024 tax return. Sole proprietors and Corporations have until April to file, unless extended until October.

Profit-sharing attracts, rewards, and retains talent.

• Profit-sharing plans can add 4-5% to an employee’s salary, which works well to attract and retain workers. Highly Compensated Employees (HCEs) can receive more generous contributions, subject to additional IRS nondiscrimination testing. A vesting schedule determines how long an employee must work for the company before they own 100% of the employer contributions, which is helpful for employee retention and cost savings.

Tax liability can be reduced with profit-sharing.

• Like any other type of 401(k), contributions are tax-deductible for employers and not subject to Social Security or Medicare withholding. Likewise, these contributions increase the employee’s retirement savings without increasing their taxable income for the year. In a good year, businesses can make the highest possible contributions and get the highest possible write-off.

Employees like profit-sharing because:

They receive more money for retirement.

• Nearly half of Americans fear they will not have enough money to maintain a comfortable lifestyle in retirement. Employers make it easy to save.

They get something for free.

• Employees do not have to contribute to the plan in order to receive the profit share. Even low earners can obtain this base retirement benefit.

No matter which formula is used, all 401(k) profit-sharing plans are subject to the following IRS rules:

Contribution Limits:

• In 2023, employers may put in the lesser of $66,000 per individual, not exceeding 25% of eligible plan compensation.

Tax Deduction Limits:

• Employers can deduct contributions up to 25% of eligible plan compensation on their taxes.

Calculations:

• Annual employer/employee contribution and testing calculations cannot use compensation in excess of $330,000 (2023 limit, may change annually) or 100% of salary.

Notices:

• Employers are not required to supply notices when the contribution is not required.

Forms:

• Form 5500 must be filed with the Department of Labor annually.

Funding Deadline:

• Partnership, LLC partnership and S-Corporation – March 16th (September 15th with extension)
• C-corporation & Sole proprietor – April 15th (October 15th with extension)
• Tax-exempt organization – May 15th (November 16th with extension)

Employers can choose from a number of profit-sharing formulas:

Pro-Rata:

• Pro-rata plans are most common, allowing everybody to receive contributions at the same uniform rate. Like the employer match, employees receive a set percentage of their compensation as a profit share. The comp-to-comp formula allows employers to offer a benefit that is easy for employees to understand.

Same Dollar Amount:

• Like the Pro-rata plan, the simple Same Dollar plan distributes profit shares equitably. Rather than basing the amount on a percentage of one’s salary, the total profit-sharing pool is simply divided by the number of eligible employees, so they all receive the same dollar amount.

New Comparability:

• Cross-testing or new comparability profit-sharing generally offers maximum flexibility for employers to make contributions at different rates. This method uses a complex set of testing methods to cross test different sets of criteria such as compensation, age, and highly compensated employee status. New comparability profit-sharing may be appropriate for businesses with fewer than 50 employees when owners are older, more highly compensated, and wish to hit their maximums.

Profit-sharing is generally a worthwhile benefit, though it may not be right for every company due to the following factors:

• The plan requires some thought each year to determine whether to offer the benefit and how much.
• Employees may view the contribution as less certain than cash incentives.
• When the company skips years of profit-sharing, there is no incentive for company loyalty.

In most cases, profit shares are offered in conjunction with a 401(k), which allows employees to put their own money into the plan–up to $26,000 a year with catch-up contributions–while employers continue contributing up to the $58,000 maximum. Combining both features creates flexibility for employee bonus structures while allowing employees and employers to save more for the future.

Starting a new 401(k) plan with profit-sharing requires a system that tracks contributions, investments, distributions, and IRS compliance. Ongoing administrative upkeep is typically outsourced to a Third-Party Administrator such as Ubiquity.

Setting up a profit-sharing plan as part of an existing 401(k) can be done by simply adding an amendment. As a 401(k) plan administrator, Ubiquity consults with clients to make sure the profit share aligns with business goals.

Profit-sharing is a generous incentive to encourage workers of all compensation levels to continue providing their best efforts while allowing maximum flexibility for employers to keep costs reasonable. Contact Ubiquity to learn more about profit-sharing benefits.