Currently the Profit Sharing plan is one the most popular retirement plans. A profit sharing plan offers the greatest flexibility and variety of options, including the ability to add a 401(k) salary deferral provision ( i.e., a 401(k) Plan).
In a profit sharing plan, the employer may make tax-deductible contributions each year for their employees (owners are also considered employees). Contributions to profit sharing plans are not required from year to year, and the amount of the contribution is generally at the discretion of the employer. Each participant shares in the allocation of the contribution based on a formula that is defined by the plan’s pre-established rules (the plan document). A participant’s share of the contribution is based on his or her salary. The plan may also take into account other factors, such as the age of the participant, when allocating the contribution.
Profit sharing plans have an annual per-participant contribution limit of $55,000. The amount of the contribution that is tax-deductible for the employer is limited to 25% of the gross annual salaries of all plan participants.
In the past, a plan called a Money Purchase Plan was the vehicle used when a guaranteed contribution was desired. For example: 5% of annual salary each year. The formula for determining the contribution was defined in the plan document. Once a year had started and participants had met the requirements to receive an allocation, the employer was required to make the contributions.
New IRS rules have increased the tax-deductible limits to traditional profit sharing plans to now be the same 25% of gross annual salaries that previously was available only under a money purchase plan.
Now a traditional profit sharing plan can be designed to accomplish the same goals. But because contributions would not be totally discretionary, these plans are much less flexible and therefore much less attractive to most plan sponsors. Currently their application is generally limited to those employers with a need to guarantee a specific contribution amount. An example of this would be an employer who has a collective bargaining agreement with a union that guarantees the union employees a specific retirement amount each year.
However, a profit sharing can also be designed to also allow for discretionary contributions along side of this guaranteed contribution. If the guaranteed level is set at less than 25% of eligible compensation, a discretionary contribution could be available.
The individual annual limits to a Traditional Profit Sharing Plan is $55,000. The amount of contribution that is tax-deductible for the employer is limited to 25% of the gross annual salaries of all plan participants.