Funding for retirement plans can vary from plan to plan. Some plans are entirely funded by the employee while others have contributions from both the employee and the employer. Others, though, like a profit-sharing retirement plan, are entirely funded by the employer. What is a profit-sharing retirement plan and how does it work? Let’s take a deeper look at how a profit-sharing plan works and if it may be right for you or your company.
What is a Cash Balance Plan? Check out our Guide
How Profit-Sharing Works
Profit-sharing is one option that employers of for-profit businesses can offer their employees for retirement planning. With profit-sharing, the contributions are usually based (but not required to be) on the profitability of the company. The amount of contribution is based on the profitability of the company for that year. This means that in better years, employers contribute more to the employee’s retirement plan.
Unlike many other forms of retirement plans, profit-sharing plans do not allow the employee to contribute to the plan. If employee contributions are added, then the plan is referred to as a 401(k) plan. There is also no set minimum contribution requirement for the employer. The plan can be adjusted often and sometimes the employer may choose not to contribute at all for a period. When the employer does contribute, they must use a set formula to determine the amount of compensation each employee receives. The percentage of profits that employees receive can be different for each employee.
Requirements for Profit Sharing
Like any retirement plan, there are a few important requirements for maintaining a profit-sharing retirement plan. Here are a few of the requirements that a business must follow to maintain compliance:
- Form 5500 needs to be filed annually.
- The IRS also requires yearly anti-discrimination testing. This is to ensure that all eligible employees are benefiting from the plan, and not just the highly compensated ones.
- Participant disclosures must be sent out each year to all employees who participate in the profit sharing.
- The contribution limit is the lesser of 100% of compensation or $58,000 annually (these limits can change, so check the IRS website for updated contribution limits).
- New plans must be established by the time the business files its taxes for the year.
Profit-sharing is just one of the many options available for retirement planning. It can be a great option for companies that are looking for a way to compensate their employees and make them feel like they have a stake in the company. This plan option also allows employees to grow their retirement savings without having to worry about making contributions of their own. They also allow for flexibility of funding for the employers: low-profit years can cost an employer a lot less if they can choose what percent, if any, of the profit will go to the profit-sharing plan.
If you are thinking of adding profit-sharing to your retirement plan options, contact California Pensions to learn how we can help you.
