Among the various retirement plans business owners can choose from, profit-sharing plans remain a popular choice among many companies. While profit-sharing plans offer certain advantages to both employers and employees, they are not without considerations. Issues can develop from poor understanding and implementation of profit-sharing into company strategies. To clarify whether profit-sharing suits your business, follow this guide to understand how profit-sharing advantages and disadvantages can impact workplace functions.
Stay Compliant with our Fiduciary and Plan Sponsor Checklist
What is Profit-Sharing?
Profit-sharing is one popular choice employers can offer to their employees as a retirement plan. Through profit-sharing, plan contributions are made by the employer—meaning owners could add to the plans—but don’t permit employee contributions. Typically profit-sharing plans do not mandate contributions, so business owners favor profit-sharing as a retirement plan offering since it assists during lean years.
Profit-sharing contributions are set at a maximum limit of either $61,000(2022) or 100% of an employee’s salary, whichever is lower; at the same time, profit-sharing contributions are capped at a maximum amount of 25% of an employers total covered compensation for the plan year.
Generally, companies can offer profit-sharing plans to all business employees; however, certain circumstances enable employers to exclude profit-sharing options from workers under reasons such as:
- Being under 21 years of age.
- Completed at least 1 year of service.
- Any participants in a collective bargaining agreement.
- Non-residents of the United States.
Outside of these minor conditions, employees stand to earn significant benefits through profit-sharing. Before signing into a retirement plan, however, it’s important to determine what advantages or disadvantages come with including profit-sharing into your strategy.
Profit-Sharing Advantages
Plan Flexibility
Compared to traditional pension plans, profit-sharing enables employers more control over eligibility terms and contribution limits, thereby allowing them more control over contributions depending on business profitability.
Incentives for Employee Loyalty
By providing profit-share options, employees have a more direct connection with employers and the business’ success than those on regular salaries. Additionally, companies who present such loyalty incentives highlight the value of employees’ daily efforts through monetary rewards, thereby improving company culture and client experiences overall.
Better Profits and Working Environment
By improving overall company positivity, profit-sharing also helps improve profits within company production. Not only does more profits improve productivity, but profit-sharing can persuade workers from looking for new employment long-term by offering benefits other companies cannot. Such a positive work culture improves employee retention, which reduces the amount spent on recruitment and training processes.
Employees may not see the benefit of receiving the employer contribution. Unlike a 401(k) where employees are actively engaged and take part in reaching their retirement savings goals, pure employer funded plans may not receive the same type of buy in or employee benefit messaging. Also, some participants may not see the benefit of receiving retirement plan funds which vest over a period of time and would rather have current income instead.
Due to the variable nature of profit sharing contributions, it becomes harder for employees to plan for the future as they do not know when and if a contribution will be made to their retirement account. One advantage of embedding profit sharing features into a 401(k) plan is that employees can still contribute to their own accounts even if the employer cannot make a profit sharing contribution.
Profit sharing plans also need to follow rules on discrimination and have notice requirements just as with any other retirement plan. Without consistent engagement from an employer and service providers, important deadlines and notice requirement can be missed.
One major consideration in plan design relates to compensation and hours. While employers have broad discretion to define compensation and plan contributions, they must take care that they follow the rules of their plan document. If employers provide their service providers with incorrect compensation, fail to give correct hours, or leave someone off the census file completely, employers can be responsible for not only missed contribution but also earnings and potential penalties.
Is a Profit-Sharing Plan Right For Your Business?
Before setting your employees up with a set contribution plan, it’s crucial that employers fully consider all profit-sharing benefits and concerns.
For more information or help deciding the type of plan for your business, contact California Pensions to get in touch with one of our experienced retirement plan professionals today.
