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Learn top strategies to reward employees (and help owners shelter more income from taxes)

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Profit-Sharing 401(k) vs. Match: Which Is Better for Employers?

David Ramirez, CFA
February 7, 2024
Profit-Sharing 401(k) vs. Match: Which Is Better for Employers?
Table of contents

If you’re a business owner considering a 401(k) plan, you’re probably thinking about which type of plan will be most beneficial for your employees. But it’s important to think about your own needs, too. A profit-sharing 401(k) plan can be a great choice if you’re looking to motivate employee performance, drive profits, and attract top talent.

Profit-sharing plans are similar to 401(k) plans with employer matches. Both allow employers to contribute to employee retirement accounts. However, profit-sharing 401(k)s allow small business owners to make contributions based on their company’s success. Additionally, these plans offer powerful tax benefits and ways for owners to maximize their personal savings.

W‍hat Is a Profit-Sharing 401(k) Retirement Plan?

A profit-sharing plan is a retirement plan where employers contribute money to eligible employees, regardless of the employee's personal contributions. These plans are popular for businesses seeking flexible ways to create tax-advantaged retirement accounts.

Employers can contribute to profit-sharing plans on their own schedule, provided the contributions are recurring and significant. Businesses must, however, define the formula for employer contributions, such as: “X% of quarterly profits, plus X% of an employee’s annual salary.”

Profit-Sharing 401(k) Plan vs. Standalone Profit-Sharing Plan

A standalone profit-sharing plan is funded solely by employer contributions. This type of plan is easy to administer — and can be an attractive perk for job-seekers — but it doesn’t allow employees to save for retirement. Plus, employees pay taxes on any profit-sharing bonuses they receive.

A profit-sharing 401(k) is a plan that allows for employee contributions and employer profit-sharing contributions. These plans can be structured as a safe harbor 401(k), meaning employers must make a minimum non-elective contribution for all eligible employees, and those contributions are immediately vested. Any additional profit-sharing contributions can have a 6-year vesting schedule.  

If employees leave before they are fully vested, their unvested contributions from profit-sharing enter a forfeiture account. Employers can use this account to cover plan expenses or fund future contributions.

Free Whitepaper: Are profit sharing 401(K)s right for you? Download now

401(k) Profit-Sharing vs. 401(k) Match Differences

Profit-share 401(k) and 401(k) match are similar but have three key differences:

  1. With a profit-sharing plan, employees receive contributions regardless of whether they save into the retirement plan. An employee only receives a match if they choose to defer part of their income in the retirement plan.
  2. Profit-sharing retirement plan contributions are typically a percentage of an employee's plan-eligible income. In contrast, the amount an employee contributes to the plan determines the match they will receive; however, employers can set a maximum matching contribution.
  3. A profit-sharing retirement plan encourages employees to focus on business goals. A company can tie contribution amounts to certain milestones, like revenue growth. The company does not need to make a profit in order to make a profit-sharing contribution.

401(k) Profit-Sharing vs. Match-Only: Owner Benefits

Profit-sharing plans help business owners maximize their personal retirement savings. For example, let's assume:

  • A business owner earns $400,000 in W-2 and K-1 income. Their 401(k) contributions will be based on the maximum 2024 plan-eligible compensation of $345,000 (up from $330,000 in 2023).
  • As both the employer and an employee, the business owner can contribute a total of $69,000 to their plan in 2024, but their maximum employee contribution is $23,000.
  • With a 401(k) match of 4%, they could contribute $13,800 as an employer to the plan, for a total of $36,800 — far short of their total contribution limit.
  • If the plan also includes a profit-sharing contribution of 2% of their salary per quarter, they would have additional contributions of $27,600 for a total of $64,400.

In this scenario, the owner only saves a lot more for retirement with a profit-sharing 401(k), and they also lower their taxable income from $400,000 to $335,000. Assuming the owner is married and filing jointly, and is the sole income earner, they’d reduce their federal tax rate to 24% from 32%.

401(k) Profit-Sharing Plan Advantages

Profit-sharing plan contributions fall under the umbrella of non-elective contributions. This means that employees are eligible for contributions even if they do not save in the 401(k). While they are similar to safe harbor non-elective contributions, profit-sharing has three distinct advantages:

Profit-sharing is discretionary

‍Unlike safe harbor contributions, profit-sharing 401(k) contributions are optional. Adding a profit-sharing feature to your plan does not obligate you to contribute. Employers can decide at the end of each year how much, if any, contributions they wish to make. If business is thriving, contribute; if not, don't.

Profit-sharing vesting can boost employee retention

Another benefit is that profit-sharing plans allow vesting, which helps retain employees. Owners can customize a vesting schedule with a 3-year cliff or even graded vesting schedules of up to 6 years. If you want to lower employee turnover, profit-sharing can help. If employees leave before they're fully vested, they might lose some or all of their contributions.

Profit-sharing is highly customizable

Plans can give equal amounts to each employee, equal percentage of pay, or favor some employees like owners or older employees. Companies can change the plan formula each year by amending the plan or using a formula that benefits employees more.

2024 Profit-Sharing Income and Contribution Limits

The cap for total contributions to the 401(k) (i.e., employee contributions + employer contributions) in 2024 is $69,000. Owners and employees over 50 can make catch-up contributions of $7,500, for a total of $76,500.  

Employer contributions cannot exceed 25% of an employee's annual compensation.  

The IRS maximum plan-eligible compensation for 2023 is $345,000.

‍Profit-Sharing Plan Formulas

There are four common ways small businesses can allocate profit-sharing:

Pro rata

Pro rata is the simplest formula for retirement plans. With this allocation, every eligible employee receives the same contribution rate (i.e., a contribution's dollar amount divided by the participant's compensation).

This formula is a straightforward, easy-to-understand benefit for employees. Moreover, since everyone gets the same benefit, pro rata contributions automatically pass IRS 401(k) nondiscrimination tests.


Age-weighted allocation formulas consider an employee's compensation, age, and years of service.

With age-weighted profit-sharing plans, older employees receive larger contributions, even if they have the same compensation as younger employees. This helps older employees rapidly build retirement savings.

Permitted disparity

Permitted disparity profit-sharing contribution formulas are more intricate and often favor higher-income employees.

The plan calculates contributions in two steps. In step one, the employer provides a pro-rata contribution based on employee pay. In step two, the employer provides an additional retirement contribution based on pay above a certain level.

Permitted disparity formulas are worth considering if your goal is to benefit highly-compensated employees (HCEs) while still automatically passing IRS nondiscrimination testing.

New comparability

New comparability is the most versatile type of profit-sharing allocation formula, and the one ForUsAll typically uses. This method allows employers to set different rates for different employee groups. While employers must pass additional nondiscrimination tests, these tests take both income and age into account. This significantly helps older owners maximize their personal tax shelter while minimizing overall plan costs.

For example, imagine a small business owner looking to maximize their 401(k) salary deferral. They could choose to exclude some or all of the other HCEs. This reduces the average benefit received by HCEs as a group, and by extension, reduces the benefit needed for non-highly compensated employees (NHCEs).

Older business owners that make more than their younger NHCEs, can significantly benefit thanks to "cross-testing." Here, profit-sharing 401(k) plans must satisfy the “gateway minimum.” NHCEs must receive at least one-third of the profit-sharing rate given to HCEs. Alternatively, they must receive 5% of their plan-eligible pay, whichever is lower.  

In short, new-comparability 401(k) profit-sharing plans can be a powerful way to maximize tax deductions for owners. However, if the owners are relatively young, it may not be the best option.‍

Profit-Sharing Nondiscrimination Testing

While offering a profit-sharing plan can be great for both employers and employees, it can bring additional complexity. More sophisticated allocation methods can complicate year-end compliance tests.  

You can add basic allocation methods to a safe harbor plan (like pro-rata) without jeopardizing the plan's safe harbor status. In fact, simple allocations automatically pass the actual contribution percentage (ACP) test.  

However, more advanced allocation methods (like new comparability) need to be cross-tested and pass the gateway test, which means NHCEs need to receive the lesser of:

  • 1/3 the contribution of HCEs); or
  • 5% of plan-eligible compensation.

How ForUsAll Can Help

ForUsAll regularly helps clients design and model retirement plans to see which option is best. If you’re considering a profit-sharing plan for your business, we can help! Let’s build your 401(k) today.

Download Profit Sharing Guide
Learn top strategies to reward employees (and help owners shelter more income from taxes)
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About Author -
David Ramirez, CFA

David Ramirez, CFA, is a recognized 401(k) expert with over 20 years of experience in 401(k), ERISA, cash balance plans, and ESOPs. A UC Berkeley graduate, he played a pivotal role at Financial Engines, a 401(k) advisory firm founded by Nobel Laureate William Sharpe, Ph.D., where he was a portfolio manager who helped manage over $50B in 401(k) assets.  His clients included some of the largest Fortune 500 companies and state governments.

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1 Schwab 2022 401(k) Participant Study - Gen Z/Millenial Focus, October 2022.
2 As of 12/31/2022. Employees include both current employees and terminated participants with a balance.
3 "Morgan Stanley At Work: The Value of a Financial Advisor" Morgan Stanley, March 2022.
4 Sarah Britton was a client when she provided this testimonial through an independent third party review website. She received no compensation for her remarks. There are no known conflicts of interest in the provision of her comments related to the services provided.