Defined Contribution Plans
Profit sharing plans are one of the simplest and yet one of the most flexible of all the defined contribution plans. The contribution is made by the employer to the plan and allocated to the participants based on a formula. The contribution may be discretionary or stated as a percent of profits. No contribution is necessary in years where there are no profits, but a contribution may be made even if there are no profits or accumulated profits. This type of plan may be sponsored by any employers, even those in the non-profit or governmental sectors. Plans sponsored by non-profit or governmental employers are generally referred to as 401(a) plans.
All profit sharing plans must have an allocation method. That is, the method used to allocate contributions to the individual participants must be specified in the plan document. There are various methods available to allocate the contributions. The benefit provided at normal retirement age is an account balance. There is no guarantee of benefits at normal retirement.
Allocation by Compensation
The IRS has defined allocating the employer non-elective contribution by a relationship of a participants compensation divided by the total of all participants compensation as a non-discriminatory method. This method gives each participant the same percentage of compensation as a contribution. Compensation should be limited to the current statutory limit. See the Profit Sharing brochure for the current limitations.
Integration with Social Security
The effect of social Security on the plan can be built into the allocation formula for the employer contribution. The plans take into consideration the fact that social Security provides a larger percentage of pay for the lower paid individuals and a smaller percentage of pay at the higher levels at retirement.
The plans are permitted to discriminate in favor of the highly compensated within the limits pro- vided by the IRS code. The amount of contribution for the highly compensated participants may be a larger percentage of pay than for the non-highly compensated participant.
Age Weighted Plans
The plan contribution is weighted by the age and compensation of each participant. The plan must pass special non-discrimination rules.
New Comparability or Class Allocation Plans
The plan allocation is based on the class of an employee. All employees are divided into classes, or each employee is placed in its own separate class. Each class is tested and the highly compensated employee class is compared to the non-highly compensated group of employees. The plan is tested using the cross-testing rules to prove it meets the non-discrimination test.
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