A profit-sharing plan, by name, suggests that it’s a way for an employer to share the company profits with the employees that maybe helped build that company. However, a plan sponsor can make a contribution even if they did not have a profit that year. Any employer with one or more employees can offer a profitsharing plan, and it generally must be offered to all employees at least age 21 who worked at least 1,000 hours in a previous year.
What are Profit Sharing Plans?
Employer contributions are discretionary. And since profits vary from year to year, there’s no set annual contribution. And contributions made to the plan must be allocated by a formula that’s set out in that plan document. An allocation formula would be percentage-based on the participant’s compensation divided by the total of all participant’s compensation times the total employer contribution. And what we find in most small profit-sharing plans, they’ll just pick a percentage, like five percent or 10 percent of compensation, and contribute that amount to each employee.
2014 Profit Sharing Plan Contribution Limits
For 2014, the amount of compensation taken into account is limited to $260,000. Employer contributions are limited to the lesser of 100 percent of compensation or $52,000 per employee for 2014. The employer’s deduction for contributions made to a profitsharing plan cannot exceed 25 percent of the aggregate compensation for all eligible participants.
Profit-sharing plans require more administration and management than IRA-based plans. These plans generally must file a 5500- series return. Profit-sharing plans must be amended from time to time to comply with changes to retirement plan laws. It’s not hard to find a plan that’s been pre-approved by the IRS. These plans are available from many financial institutions.
A profit-sharing plan can be designed to be a better fit to the needs of the owner and the employees. A profit-sharing plan can exclude employees that work less than 1,000 hours, compared to a SEP that must include all employees that earn just $550 in three of the five years. Five hundred and fifty dollars in a year may not even be two weeks worth of work.
Excluding Certain Employees from Profit Sharing Plan
A profit-sharing plan can exclude many of those temporary employees. Also unlike a SEP, a profit-sharing plan can have a vesting schedule, which can require participants to work for the employer for several years before they own the contributions. You end up rewarding the employees that stay with you that are longer contributors to the success of your business.
Also, profit-sharing plans can be designed to provide contribution allocations that are not the same for all compensation levels. They may also allow loans to participants. Like all qualified plans, money in a profit-sharing plan is covered by ERISA, the Employee Retirement Income Security Act. It is the ultimate protection from creditors. Money in an IRA is subject to each state’s law.
Form 5500 and Profit Sharing Plans
Again, profit-sharing plans have the Form 5500 return filing requirement while SEPs do not. And laws that affect profitsharing plans are changed more often than those affecting SEPs. In a profit-sharing plan, to make a contribution for 2014, the plan must be adopted by December 31, 2014. A straight profit-sharing plan – that’s one that doesn’t try to exclude classes of employees, counts all compensation, doesn’t require participants to be employed on the last day of the plan year and allocates the same contribution percentage to each participant – can be very easy to administer. If you choose to design your plan to exclude compensation, for instance, excluding bonuses, for example, or certain employees and maximize contributions towards the higher paid employees, the administrative complexity grows considerably.