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Profit Sharing Plans

Profit Sharing Plans are another popular retirement plan option available to small and mid-sized businesses. They offer flexibility to employers and are easy for participants to understand.

The contributions are not actually based on the profitability of the company, but rather the compensation of the eligible employees. The company is allowed to contribute from 0% up to 25% of eligible compensation into a Profit Sharing Trust account on a pre-tax basis each year. The contributions are allocated to participants based on one of the following formulas:

Pro Rata Formula

A traditional Profit Sharing plan has a pro-rata allocation formula. If the company contributes 10% of compensation into the Plan than each eligible employee is allocated 10% of their compensation.

Integrated Formula

Another approach that may be used is called an integrated allocation formula. This type of plan allows social security benefits to be considered when testing for non-discrimination. Employees who have compensation greater than the social security cap do not receive the equivalent benefits of lower paid employees when you combine profit sharing contributions and social security benefits. As a result, employees with compensation greater than the social security wage base may receive an extra contribution to even out the overall benefits.

Age-Weighted Formula

This type of formula uses age as well as compensation to allocate plan contributions among eligible employees. Non-discrimination is proved based on the benefits the employees receive at retirement age. Older employees have less time to accumulate contributions before retirement; consequently, they must receive higher allocations today.

Tiered or "Cross-Tested" Formula

This type of formula allows the employer to separate employees into different groups (or tiers). Each tier may have a different allocation formula subject to non-discrimination testing requirements. This type of plan allows the employer to specifically tailor the plan to the goals of the company and reward certain employees at higher levels than others. The tier groups can be determined based on a number of factors including: job description, length of service, performance goals, etc.