401(K) Profit Sharing Plan
A profit-sharing plan gives employees a share in the profits of the company. Each employee receives a percentage of those profits based on the company’s earnings. Also known as “deferred profit-sharing plan.”
What is a profit-sharing plan?
Profit-sharing plans are attractive to many business owners because of their flexibility. A company will be able to decide how much employees will receive on a year-by-year basis, depending on the amount of revenue the business makes. There are no required contributions. If one year exhibits poor performance, the employer can either eliminate the profit-sharing for that year or give a smaller amount.
Contributions can equal the lesser amount of up to 25 percent of an employee’s salary, or $55,000. This amount may change based on inflation.
Many businesses use vesting schedules to detail how long individuals must work for the company before they can claim their profit-sharing, including when they move to another job or retire. Once employees become fully vested, they are eligible to receive the entire amount. This money may be rolled over into an IRA account or into a new employer’s retirement plan.
What are the benefits of a profit-sharing plan?
Businesses of any size may offer this plan. Companies may offer other retirement plans in conjunction with the profit-sharing ones. Also, this plan tends to serve as an incentive for employee engagement and retention. When employees feel like they are vested in a company and are part of its success, they are likely to work harder. Employees will look forward to obtaining their share of the company’s profits.
Who may establish a profit-sharing plan?
Any employer is eligible to establish a profit-sharing plan.
Who may participate in a profit-sharing plan?
Both employers and employees may participate in this plan.
How is a profit-sharing plan established?
- Adopt a written plan, called the plan document, which outlines its day-to-day operations.
- Identify a plan provider and/or trust for the plan’s assets and investments.
- Select a recordkeeper or recordkeeping system to track contributions, earnings and losses, and distributions. This person or entity will also help prepare the annual return, which must be filed with the federal government.
- Select a third party administrator to maintain the retirement plan document, fulfill daily tasks and ensure compliance with federal regulations. Your financial advisor may choose a third-party administrator and/or recordkeeper on your behalf.
- Provide eligible employees, or plan participants, with a summary plan document (SPD), which is the document that outlines who can participate and how the plan works.
The written plan also provides a central document, or collection of documents, which explains the rights of the employees and employee eligibility for participating in the plan and enables government agencies to determine whether it satisfies applicable laws.
If the plan allocates responsibilities for performing administrative functions to other parties, such allocation must identify who is responsible for ensuring compliance with the requirements of the tax code, including compliance requirements for loans and distributions.
In the case of funding through multiple financial institutions, the employer may adopt a single written plan to coordinate administration among the financial institutions, rather than having a separate document for each issuer.