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401k Profit-Sharing Plan

Profit-Sharing is a feature that can be added to a normal 401(k) plan to help your employees save for retirement.

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Small businesses create 401k profit-sharing plans to help employees save for retirement, while allowing for maximum flexibility on how much the plan costs. Employers can decide from year to year whether they want to make contributions to employee plans depending on how much revenue the company earned that year.

Even if employees themselves do not wish to take advantage of tax-deferred savings, they can still receive the profit-share contribution. Compared to 401k matching contribution formulas, employers find a wider range of options with profit-sharing, though there may be limitations based on IRS nondiscrimination test rules.

Contacting Ubiquity to inquire about creating a 401k profit-sharing plan or adding profit-sharing to an existing 401k is the best way to know whether this type of plan is right for your company. See below for further helpful information.

How Profit-Sharing Works

  • Profit-sharing is typically offered as a 401k 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 401k.
  • Unlike a Safe Harbor 401k, 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 401k, distributions taken before age 59.5 are subject to a 10% penalty.

Benefits of Profit-Sharing for Employers

Employers like profit-sharing plans because:

They can better control 401k costs.

  • The flexible contributions are an excellent choice for start-ups, erratic industries, or companies that are frequently acquiring 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 2021 tax filing deadline to decide on their contributions unless extended until September, while deducting them on the 2020 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 401k, 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.

Benefits of Profit-Sharing for Employees

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.

Profit-Sharing Rules and Limits

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

Contribution Limits:

  • In 2020, employers may put in the lesser of $57,000 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$285,000 (2020 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)

Common Profit-Sharing Formulas

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-Rate plan, the simplistic 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.

Reasons Not to Offer Profit-Sharing?

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.

Combining Profit Shares with 401ks

In most cases, profit shares are offered in conjunction with a 401k, which allows employees to put their own money into the plan – up to $26,000 a year – while employers continue contributing up to the $57,000 maximum. Combining both features creates flexibility for employee bonus structures, while allowing employees and employers to save more for the future.

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

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

All in all, 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.

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44 Montgomery Street, Suite 3060
San Francisco, CA 94104
Support: 855.401.4357

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© 2020 Ubiquity Retirement + Savings
Privacy Policy
44 Montgomery Street, Suite 3060
San Francisco, CA 94104
Support: 855.401.4357

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