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Retirement Plan Types: Profit Sharing

Profit Sharing Plan Overview

Employers who desire flexibility in the amount of their annual contribution traditionally use Profit Sharing Plans. Often, this is an employer whose annual profit fluctuates and therefore cannot commit to an annual required contribution. Under a Profit Sharing Plan, an employer agrees to make annual contributions but these contributions are discretionary. Contributions are invested on behalf of the plan participants. Distributions are made to participants at retirement, death, disability, or termination of employment.

Profit Sharing Plans work best for a company that:

  • Prefers a flexible annual contribution.
  • Wishes to provide a vesting schedule to reward employees who remain employed for many years.
  • Does not wish to contribute to part-time and/or temporary employees, as defined by IRS guidelines.

Additional information pertinent to Profit Sharing Plans:

  • Employer contributions may vary from 0% to 25% of the total annual eligible payroll and are usually determined after the close of each plan year.
  • Total allocations (contributions plus forfeitures) to a single participant cannot exceed 100% of individual compensation or the annual addition limit in effect for that year ($54,000 for 2017).
  • The annual compensation limit is $270,000 for plan years beginning in 2017.
  • A Highly Compensated Employee is anyone in the current or look-back year who is a 5% owner or received compensation of more than $120,000 in 2017.
  • Contributions and administrative expenses paid by the plan sponsor are tax deductible.
  • The Internal Revenue Code generally requires that the employer make “substantial and recurring” contributions and the plan must satisfy annual nondiscrimination testing guidelines.
  • Plans must provide for minimum benefits in any year that the plan is determined to be top-heavy.

The NRS “Profit Sharing Portfolio” (Profit Sharing Allocation Methods)

Retirement planning is important in today’s world where employers are faced with more responsibility for providing adequate retirement savings for themselves and their employees. Our “Profit Sharing Portfolio” illustrates the four major allocation methods available today: Salary Ratio, Social Security Integration, Age-Weighted Compensation, and New Comparability. Review the following descriptions to see which most closely meets your objectives.

Salary Ratio Allocation Method

The Salary Ratio Plan is the simplest of the four allocation methods. It is designed to allocate employer contributions to all participants in proportion to their compensation. For example, if one employee receives 10% of his compensation as a contribution, all employees who are eligible will receive a contribution equal to 10% of their compensation.

The Salary Ratio Plan should be used for employers where there are no distinct salary or age differences in employees or where the employer does not wish to target any particular employees for higher contributions.

Social Security Integration Allocation Method

Employees who are earning compensation in excess of the Social Security Taxable Wage Base ($127,200 for 2017) accrue no government-provided social security retirement benefits on compensation that exceeds that amount. In order for those employees to have retirement income more comparable to their current income, the Internal Revenue Service allows additional allocations to such employees based on their compensation above the Social Security Taxable Wage Base.

With this allocation method, an employer, still limited to a total plan contribution not greater than 25% of total eligible payroll, can provide highly compensated employees a larger allocation of contribution than the lower-paid employees.

Social Security Integration Plans should be used when employees who are targeted to receive larger allocations are more highly compensated than all other employees, but whose age is the same or younger than other employees.

Age-Weighted Allocation Method

The Age-Weighted Plan allows employers to allocate contributions based on the age and compensation of eligible employees. Age-Weighted Plans greatly benefit employees who are older and have fewer years than younger employees to accumulate sufficient funds for retirement. This could be owners, officers or other employees. Special discrimination testing is required.

Age-Weighted Plans should be used when the employees to whom the employer wishes to target larger allocations, are both older and more highly compensated than all other employees. These plans are generally designed to be top-heavy.

New Comparability Allocation Method

The New Comparability Plan allows the employer to divide the employees into specific groups and allocate the contribution differently to each group. The employer can give a larger share of the company's contribution to those employees whom the employer wishes to benefit.

Discrimination testing under a New Comparability allocation formula is achieved by either testing contributions alone or converting contributions to an Equivalent Benefit Accrual Rate (EBAR) similar to those used in defined benefit plans. These accrued benefits are then tested against each other to pass discrimination tests. This is usually a complicated set of calculations and normally requires actuarial consulting, but is still less expensive and more flexible than a defined benefit plan.

New Comparability Plans are generally used when the employer wishes to target older highly compensated employees for larger contribution allocations. These plans are also designed to be top-heavy.

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