Profit sharing plans offer both design flexibility and discretion as to making contributions. Company contributions are determined by the employer and can be allocated in a number of ways. If the company makes little or no profit during a year, no contribution is required, although low profits don’t restrict the contribution level. A profit sharing plan can include an option allowing the company to make contributions even if the company has no profit.
Eligibility
Typically, the eligibility provisions require an employee to have one year of service and be at least 21 years of age. A two-year service period may be imposed if full immediate vesting is provided. For most plans, a year of service is defined as working 1,000 hours in a plan year.
Contributions
An employer’s maximum deduction is limited to 25% of the annual compensation paid to eligible employees. The individual maximum contribution limits for employees applied to all defined contribution plans are the lesser of 100% of compensation or $46,000 for 2009. Depending on the allocation formula in a profit sharing plan, the contributions for individual employees may exceed the 25% level as long as the aggregated employer contribution does not exceed the 25% maximum employer contribution limit.
Advantages
The employer can make a discretionary contribution each year, which can be subject to a vesting schedule. A profit sharing plan may be integrated with Social Security or may utilize one of the allocation methods described in a later section of this brochure.
Age-weighted or Comparability (cross-tested) Profit Sharing Plans
These plans utilize allocation methods that base contributions on both the age and compensation of eligible employees, similar in concept to a defined benefit pension plan, but with discretionary contributions. Treasury regulations adopted in 1991 allow profit sharing plan nondiscrimination testing under Section 401(a)(4) to be based on anticipated benefits at retirement, similar to defined benefit plans, as opposed to the level of contributions made in that particular year, as defined contribution plans had been required to do in the past.
Eligibility
Employee eligibility requirements for age-weighted or comparability profit sharing plans are the same as those for regular profit sharing plans.
Contributions
In an age-weighted plan, the participant’s age, or length of time until retirement, is factored into the allocation formula on an individual basis, so older participants receive a larger proportionate share of the contribution. The comparability plan allows the employer to select classes of employees that provide for different contribution allocation levels for each group. If the nondiscrimination tests are met, the employer can allocate a larger proportionate share of the company’s contribution to specific employees the employer wishes to benefit the most.
Advantages
An age-weighted plan may be appropriate if a business wants to favor older, highly paid participants. Comparability plans allow an allocation that benefits a specific class of employees. If the favored group is, on an aggregated basis, older than other classes of employees, the allocation formula is likely to pass the required nondiscrimination tests.
