Defined Contribution Plan
Profit Sharing Plans
Profit Sharing Plan
A profit sharing plan is a defined contribution plan to which an employer makes contributions on behalf of the employees. The employer contribution is discretionary. The maximum annual contribution that can be allocated to the account of a employee is the lesser of 100% of the employee's compensation, or $55,000 (for 2018). This limit is adjusted each year to reflect changes in the cost of living index. For tax deduction purposes, the contribution cannot exceed 25% of the total compensation of all employees. The contribution is usually allocated to employees in proportion to their compensation. Contributions may be integrated with Social Security which will result in larger allocation for higher paid employees. A profit sharing plan is one of the most flexible qualified plans available because contribution is discretionary.
401 (k) Profit Sharing Plan
Most profit sharing plans have a 401(k) feature that allows employees to defer their compensation in addition to receiving the profit sharing contribution. This added feature allows greater flexibility for the employer and is an important consideration in the design process. This feature allows business owners to defer a portion of their compensation without having to share it in the allocation process with other employees.
New Comparability Profit Sharing Plan
New comparability plans are also known as “cross-tested” plans. Under this plan, the employer can provide higher contribution for certain groups of employees (e.g., owner and management) and lower contribution for others. In order to achieve the different contribution percentages, these defined contribution plans are tested for nondiscrimination requirements as defined benefit plans (cross-testing). These plans are generally utilized by small businesses that want to maximize contributions to owners and other highly paid employees while minimizing employees’ allocation.
Age-Weighted Profit Sharing Plan
Profit sharing plans may also use an age-weighted allocation formula that takes into account each employee's age. This results in a significantly larger contribution to employees who are older. Age-weighted profit sharing plans combine the flexibility of a profit sharing plan with the ability to provide larger benefits to older employees.
