Profit-Sharing Plan

A Profit-Sharing Plan is a defined contribution plan which allows Employers to make contributions on behalf of their eligible employees.

Profit-sharing
plans

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Proft-Sharing plan with employees and employers

A Profit Sharing Plan is a defined contribution plan which allows Employers to make contributions on behalf of their eligible employees.

  • All contributions to the plan and investment earnings compound tax-deferred until withdrawn at retirement.
  • Profits are not required to make a contribution to the plan.
  • Contributions to the plan are discretionary, which allows the employer to increase or decrease contributions based on company performance.  Or the Employer has the option not to contribute during a particular plan year.
  • Contributions are deductible on the Employer’s federal income tax return.

 

In a Profit Sharing Plan, there is generally no stated contribution formula. Rather, the plan’s language provides that the employer will determine at its discretion how much to contribute each year. While a specific contribution formula is generally not stated, the allocation formula for any contribution made is required to be stated. The allocation formula defines how participants share in the contribution the employer chooses to make.
There are four basic allocation formulas: Non-Integrated, Integrated, Age-Weighted, and New Comparability.

Retirement Nest Egg

Non-Integrated—Under this method, each participant’s allocation is based on either:

  • the same percentage of pay (also known as salary ratio),
  • the same dollar amount,
  • the same dollar amount per hour of service, or
  • the same proportion of a points system defined in the plan.

Integrated—This method is a way of recognizing compensation earned in excess of a percentage of the Taxable Wage Base; or the amount up to which FICA taxes apply (i.e., Social Security). In 2014, the Taxable Wage Base is $117,000. In many small to mid-sized businesses, only the owners and other key executives earn compensation in excess of the Taxable Wage Base. An integrated design is a way to compensate such employees that do not receive Social Security benefits on the portion of their pay that exceeds the Taxable Wage Base.

Age-Weighted—In an Age-Weighted plan, the employer’s discretionary contribution is allocated to reflect both the participant’s age and compensation. The overall allocation rate is mathematically backed into, such that the effective accrual rate for each participant is generally the same. This means that older participants receive greater percent of pay allocations than younger participants because of their shorter time to the retirement age defined in the plan.

New Comparability—The New Comparability method offers the flexibility of permitting different percentage of pay allocations to different groups of employees as defined in the plan document. The New Comparability method may often fail if tested for non-discrimination on the basis of contributions; but then can pass non-discrimination testing by testing on a benefits basis.

Profit-Sharing Blogs