Archive for the ‘401(k)s’ Category

Profit Sharing Plans

There are two basic types of Profit Sharing Plans:

  1. Cash or Bonus Plans, whereby the employee receives cash at the end of the year and is taxed on the amount at the same time, and
  2. Qualified Deferred Profit Sharing Plans which deposit funds into separate employee accounts to be distributed and taxed at a future date.

Profit Sharing Plans are often used in conjunction with 401(k) plans.

Benefits to The Employer:

  1. The employer is not obligated every year, to contribute a set amount or any amount, as long as the contributions are generally significant and recurring.
  2. The employer can limit which employees are eligible to receive benefits, based on months in service, age, or coverage in a union plan.
  3. The employer can limit how much certain employees may receive based upon rank or salary level.
  4. Investment risks lie completely with the employee.
  5. Contributions are tax deductible by the company, up to 25 percent of covered payroll. (Although an employer is limited to contributing only up to 15 percent of covered payroll, if in a prior year the employer only contributed 5 percent, the employer would be allowed to contribute an additional 10 percent to the current year’s 15 percent).
  6. Vesting allows the employer to reward employees who devote years to the company while penalizing those who terminate early, enabling the employer to retain the most experienced workers.
  7. If an employee leaves before completing a vesting schedule, the employer has the option of using the forfeited funds to reduce future allocations of profit or may divide the amount among the accounts of the remaining employees.

Benefits to the Employees:

  1. All contributions are made by the employer.
  2. Employees do not presently pay taxes on the contributions.
  3. Generally, the employee may have an IRA in addition to the profit sharing plan.
  4. Participants may borrow from the plan if the plan permits.

Allocation of Benefits

Four common plans for allocation of benefits are:

  • Non-Integrated Plans – All employees’ benefits are in direct proportion to participant compensation. For instance, all employees receive x percent of their compensation.
  • Integrated Plans – participants with compensation in excess of the plan"s wage base can receive proportionally higher contributions than participants with lower annual compensation.
  • Age Weighted Plans – Provides higher benefits to older employees according to how many years remain until retirement.
  • New Comparability Plans – Allows the employer to allocate different percentages of benefits based on classifications, i.e., executive, administration, skilled laborer, unskilled laborer, etc.

As you can see Profit Sharing Plans provide great flexibility to employers. These plans are especially popular with companies having few owners or one, employers whose owners or key employees are significantly older than the rest of the workers, or where the objective is to provide the maximum benefits to executives and higher compensated employees while minimizing benefit costs to rank and file workers.

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Now let’s take a look at the different 401(k) plans available today.

There are basically 3 types of 401(k)s and an automatic 401(k) feature that may be applied to any of these.

Traditional 401(k)
With a traditional 401(k) plan the employer decides whether or not the company will contribute to the plan and may contribute a percentage of each employee’s compensation to the employee’s account (called a nonelective contribution), or may match the amount employees decide to contribute (within the limits of current law) or may do both. The employer may also have the flexibility of changing the amount of nonelective contributions each year, according to business conditions.
If the employer does contribute to the plan a vesting schedule may be applied for employer contributions.
These plans are subject to annual nondiscrimination testing to ensure that the amount of contributions made on behalf of rank-and-file employees is proportional to contributions made on behalf of owners and managers.

Safe Harbor 401(k)

Under a safe harbor plan, the employer must match each eligible employee’s contribution, dollar-for-dollar, up to 3 percent of the employee’s compensation, and 50 cents on the dollar for the employee’s contribution that exceeds 3 percent, but not 5 percent, of the employee’s compensation or may make a nonelective contribution equal to 3 percent of compensation to each eligible employee’s account.
All employer contributions are 100% vested and the plans are not subject to annual nondiscrimination testing.

SIMPLE 401(k)

Employer contributions to a SIMPLE 401(k) plan are limited to either a dollar-for-dollar matching contribution, up to 3 percent of pay; or a nonelective contribution of 2 percent of pay for each eligible employee.
No other employer contributions can be made to a SIMPLE 401(k) plan, and employees cannot participate in any other retirement plan of the employer. All employer contributions are 100% vested and the plans are not subject to annual nondiscrimination testing.

For a plan to qualify as an Automatic 401(k) the following conditions must be true.

  • Initial automatic employee contribution must be at least 3 percent of compensation. If initial employee contributions are less than 6 percent they must be set to automatically increase so that, by the fifth year, employee contribution is at least 6 percent of compensation.
  • Employee contributions are limited to $16,500 for 2009 and 2010 with an additional catch up contributions allowed of $5,500 for participants 50 and over.
  • Employer contributions must be at least a matching contribution, up to 1 percent of pay and a 50 percent match for all salary deferrals above 1 percent but no more than 6 percent of compensation; or a nonelective contribution of 3 percent of pay to all participants.

In part 4 of our series we will examine Roth plans, Profit Sharing Plans and the New Comparability Profit Sharing Plan.

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