What is a Profit Sharing 401(k) Plan?A 401(k) profit sharing plan is one of the most basic retirement plans that allows for both employee and employer contributions. This type of plan design may allow the employer the right to decide how much they want to contribute to the plan or be based on a formula outlined in the plan document. Sometimes, the amount the employer contributes is determined based on the employee’s salary, but the employer can settle on any amount or choose not to contribute at all.
Why Start a 401(k) Profit Sharing Plan?You may be wondering if a profit sharing 401(k) is worth it for your business. Here are just a few of the benefits of starting a profit sharing plan:
- Attract and retain employees
- Minimize administrative duties (since employees can take 401(k) accounts with them to their next job)
- Grow contributions through investments
- Enjoy tax-free contributions
How Does a 401(k) Profit Sharing Plan Work?Here are the basic steps to using a profit sharing plan:
- A business determines the formula to be used for profit sharing contributions and designates it in the plan document.
- Money is then contributed to an employee’s 401(k) as a fixed dollar amount, as a percentage of their salary, or based on the amounts needed to pass compliance testing.
- Contributions are made up to the annual 401(k) profit sharing limit set by the IRS – a limit subject to change on an annual basis, but is not required to do so.
Important DefinitionsIt’s important to understand a few basic key definitions when setting up a 401(k) profit sharing plan. Note these terms before you set up your profit sharing plan:
- Fiduciary: People or entities in a position of trust in regards to the beneficiaries of the 401k plan.
- Plan sponsor: A business looking for solutions to allocate contributions so employees are ready for retirement and the company earns tax benefits.