If you’re just starting your research into profit-sharing plans, it may appear that profit-sharing plans are much like a 401(k) plan with a match from an employer. Both involve employers giving employees a certain amount of money in a given year. These contributions are put into a tax-deferred account, which means both the employer contributions and the investment earnings an employee might make are tax-deferred until the employee starts withdrawing money from the account, usually after retirement.
A 401(k) plan with a match and a profit-sharing plan are both retirement plan options that provide an employee with a contribution from their employer – but they differ in two important ways.
Essentially, the profit-sharing plan puts the employer in control, and allows employers to determine key requirements for who’s eligible to receive the tax-deferred contributions.
And, while both 401(k) employer match and profit-sharing can be put on “pause” in any given year, the profit-sharing plan is modeled to incentivize employees to work harder during the year to boost the potential contribution amount the employee can receive. Why? Because profit-sharing contributions are typically tied to annual profits, while an employer match on the 401(k) is simply tied to each individual employee’s contribution.
Tying the employer contribution to a company’s profit is key as we go into the first critical difference between a 401(k) employer match and a profit-sharing plan.
While profit-sharing plans that give every employee a contribution do exist — similar to an employer 401(k) match, being able to tailor contribution amounts to specific employees is a differentiator with the profit-sharing plan.
By giving employers flexibility in designing key features, employers can now choose how much to contribute to the plan and which specific employees will receive the contributions. This opens the door for employers to:
Just like employer 401(k) matching contributions, profit-sharing contributions are also tax deductible for the business (and depending on how the business is organized, these deductions may flow right through to the owner’s personal return). But through the profit-sharing plan, employers can put up to $53,000 into each employee’s account and deduct those amounts from the company’s taxes — much higher than the $36,000 contribution limit solely through the 401(k). And this amount is higher for those over 50 years old using catch-up contributions, where the annual contribution limit for 2017 is $59,000.
However, one thing to look out for from the employer perspective is the additional maintenance and administrative work that goes into a profit-sharing plan versus a more simple retirement plan like a SEP or a SIMPLE IRA. In addition to the added administrative work, employers will need to keep a close eye on the annual IRS testing to ensure they aren’t in a position to fail the nondiscrimination tests. If you already have a retirement advisor, find out how much of the additional work they’ll take on if you wish to offer a profit-sharing plan. A few good questions to ask are:
ForUsAll’s standard profit sharing method is new comparability – which gives employers a lot of flexibility in how they award profit sharing allocations. With this type of plan, contributions are not allocated strictly as a percentage of compensation. This flexibility provides the ability to reward employees based on seniority, tenure, salary levels, function and more to encourage employee retention (and retirement success!). New comparability may also allow business owners to improve their own retirement situation by boosting tax-advantaged contributions to their own profit sharing accounts.
Another advantage to new comparability plans, and to the plan design ForUsAll generally recommends, is that companies can be flexible in the amount of profit sharing they offer any given year – and can choose the allocations at the end of the year. Therefore, an employer can make a decision on how generous to be, and can adjust downward the allocations in lean years and increase them in highly productive years.
Give your employees more than just a 401(k), join the movement.