What Is a Profit Sharing Plan?
A Profit Sharing Plan is a Defined Contribution (DC) Plan in which contributions
each year are discretionary and, effective 1/1/02, cannot exceed 25% of
the sum of all eligible participants payroll (up from 15%).
It is an individual account Plan. Thus, the ultimate retirement benefit/amount is
the actual account value that has been credited with contributions an investment
experience through the years. There are various types of Profit Sharing Plans...each
type is dependent on the contribution allocation method and plan features. Due to
the flexible nature of the contribution, it is best suited for new businesses or firms
whose income fluctuates from year to year. Types of Profit Sharing Plans/allocation
Formulas include:
 | Age Based/Weighted |
| Integrated with Social Security |
| "Super Integrated or Comparability |
| 401(k) Plan |
Age Based/Weighted Profit Sharing Plan
An Age Based Profit Sharing Plan is one that uses both age and compensation as a
basis for allocating employer contributions among Plan participants. This concept is
similar to Target Benefit Plans. However, with a Profit Sharing Plan, contributions
are not mandatory.
Age based Profit Sharing Plans, like Target Benefit Plans, tend to favor older higher paid individuals.
Integrated Profit Sharing Plan
This type of allocation method is integrated with an overall retirement scheme that
includes Social Security; this combination is called "permitted
disparity". By providing for permitted disparity in it's qualified retirement
plan, the employer gets the benefit of it's Social Security Tax payments.
Under an Integrated Profit Sharing Plan compensation is broken out into two parts; the
amount above the integration level (excess compensation), and the amount below the
integration level (base compensation). Usually the integration level is the Social
Security Taxable Wage Base in effect for the applicable year. The employer is
permitted to "offset" their contribution to Social Security by applying a lower
contribution percentage to the base compensation (i.e.: the base percentage) and a higher
contribution percentage to the excess compensation (i.e.: the excess percentage).
However, there is a limit or "permitted disparity" between the base percentage and the excess percentage. The permitted disparity depends on the contribution level to the Plan. Generally, this type of allocation formula tends to favor higher paid employees.
Comparability Plan
In this type of Plan, the employer segregates the eligible employees
into "non-discriminatory" categories (i.e.: job description, title, hourly vs.
salaried, etc.) and designates different contribution rates for each group.
Because of the potential for discrimination in favor of "Highly Compensated
Employees" this type of Plan is required to perform special tests each year to ensure
that the contributions do not violate IRC Sec. 401(a)(4) and 410(b) non-discrimination
regulations. If the Plan does not pass these tests, the contribution rates for
some/all groups must be adjusted. Also effective beginning with the 2002
plan year, in most cases, each NHC cannot receive a contribution
that is less than 5% of salary regardless of the results of the
non-discrimination tests
This type of Plan is normally designed to favor the highly compensated employees.
However, it can be designed to favor any group of employees assuming the annual
"non-discrimination" requirements are satisfied.
401(k) Plan
A 401(k) Plan offers participants an election to defer a portion of their
salary into the Plan. The funds that are deferred are not included in current income
until they are withdrawn from the Plan. However, amounts deferred into the Plan
generally may not be distributed without penalty until the employee retires, becomes
disabled, dies, or reaches age 59 1/2.
In addition to employee deferrals, the Plan may also
provide for an employer contribution. This contribution may be in the form of a
Matching Contribution or a Discretionary Contribution. Discretionary contributions
may be allocated either a level percentage of pay for all, or by one of the methods listed
above.
For more information on 401(k) Plans please click here----->
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