What is a Profit Sharing Plan
A profit-sharing plan, also known as a deferred profit-sharing plan or DPSP, is a plan that gives employees a share in the profits of a company. Under this type of plan, an employee receives a percentage of a company's profits based on its quarterly or annual earnings. This is a great way for a business to give its employees a sense of ownership in the company, but there are typically restrictions as to when and how a person can withdraw these funds without penalties. A profit-sharing plan accepts discretionary employer contributions. There is no set amount that the law requires you to contribute. If you can afford to make some amount of contributions to the plan for a particular year, you can do so. Other years, you do not need to make contributions. Also, your business does not need profits to make contributions to a profit-sharing plan.
If you establish a profit-sharing plan, you:
- Can have other retirement plans
- Can be a business of any size
- Need to annually file a Form 5500
Profit Sharing Plans & 401 (k) Plans
Profit Sharing plans are often paired with 401(k) Plans. A variety of profit sharing formulas are available including pro-rata, integrated, age-weighted and new comparability. We can help determine which formula is best for your organization.
One common method for determining each participant’s allocation in a profit-sharing plan is the “comp-to-comp” method. Under this method, the employer calculates the sum of all of its employees’ compensation. To determine each employee’s allocation of the employer’s contribution, you divide the employee’s compensation (employee “comp”) by the total comp. You then multiply each employee’s fraction by the amount of the employer contribution. Using this method will get you each employee’s share of the employer contribution.
Also known as Permitted Disparity, the Integration method is a way of recognizing compensation earned in excess of a percentage of the Taxable Wage Base (TWB). Integration is considered a uniform allocation method because it takes into consideration that the Social Security system favors employees that earn amounts under the Taxable Wage Base.
New Comparability Option
The New Comparability allocation method allows the employer to split its employees into groups and to assign different allocation percentages to each group. Classifications may be defined in a number of ways, the most common of which is by job title. Classifications may also be based on the employer’s different geographic locations, subsidiaries, employee types (i.e., union vs. non-union or hourly vs. salaried), and other similar bona fide business criteria. This allocation method has to pass certain non-discrimination tests, however, this method usually allows maximum allocation for the owner while minimizing costs to employees.