Broker Check

Let’s Talk: Profit Sharing Plans

| December 01, 2017
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Let’s Talk - This is a fairly basic overview of a profit sharing plan, how it works, and whether it might be a fit for your company.  If you have additional questions feel free to reach out and ask me. 

In my opinion, the biggest benefit of a profit sharing plan comes from overall employee happiness, pride and retention.  When employees are given incentives to make the company more profitable it will give them a sense of pride and a feeling of respect.  However, this benefit can only be achieved if the employees understand that the company has set this up as incentive, and appreciation for all their hard work.  Having a good retirement plan advisor should help achieve this. 

Overview - A profit-sharing plan has its pros and cons, but if the company is at the right stage the pros tend to outweigh the cons.  All employer contributions are discretionary which means there is no set amount that the law requires you to contribute.  You may make contributions one year (even when there are no profits), and then not make any the next year.  Any contributions are made according to a set formula to determine how the contributions are divided. 

Let’s use the “comp-to-comp” method as an example of how contributions are spread out. First you add up all the employees’ compensation.  Next, you divide the employee’s compensation by the total comp to get their percentage of the entire profit sharing contribution, and then multiply that percent by the total contribution to get their share.

Pros

  • Flexible contributions (strictly discretionary).
  • Tax-deductible employer contributions.
  • Tax-deferred earnings growth.
  • Great way to show appreciation and provide incentive to employees.
  • Good plan if cash flow is an issue.

Cons

  • If you have a small company the administrative costs may be higher than under more basic arrangements (SEP or SIMPLE IRA plans).
  • There are tests that need to be passed so the plan doesn’t favor highly compensated employees.
  • Employer contributions only (unless part of a 401k plan).

Other Information

  • Contribution limits - The lesser of 25% of compensation or $55,000 (for 2018; $54,000 for 2017, subject to cost-of-living adjustments for later years).
  • Participant loans are permitted
  • In-service withdrawals - Yes, but subject to possible 10% additional tax if under age 59-1/2 and no other exception applies.
  • Files a form 5500
  • No company size restrictions.
  • Can have other retirement plans in place.
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