- Learn the top 5 advantages of 401(k) profit-sharing plans.
- Discover the disadvantages of profit-sharing plans.
If you are an employer looking for an attractive employee benefit that lets you plan contributions around your revenues, consider a 401(k) profit-sharing plan. These plans allow you to make pre-tax deposits to your employees’ eligible retirement accounts after the end of each calendar year. They also provide the flexibility to determine exactly how much you want to contribute based on your finances and goals. Want more information on these valuable plans? Fiducial has more below!
The Top Five Advantages of 401(K) Profit-Sharing Plans
You can pay out tax-advantaged bonuses
If your company pays employees year-end bonuses, 401(k) profit-sharing contributions can be an excellent part of that plan. They are tax-deductible to your company and don’t increase employees’ taxable income, and they are not subject to federal withholding. And they do all of this while adding to their retirement savings! These value-added benefits make the 401(k) profit-sharing contribution a great way to enhance your annual bonus program.
It adds to your ability to reward Highly Compensated Employees (HCEs)
One of the few drawbacks to 401(k) plans is the annual deferral limit that the IRS places on contributions. These limits ($19,500 in 2021) prevent Highly Compensated Employees (HCEs) from maximizing the amount that can be contributed to their accounts based on compliance limits for nondiscrimination testing. But, profit-sharing plans circumvent these restrictions. They allow HCEs to contribute a combination of up to $58,000 (with an additional $6,500 catch-up for employees age 50+) as a bonus.
It provides additional flexibility for budgeting
As nice as it would be to promise high bonuses for year-end, unpredictable revenues make doing so a recipe for disaster. By paying out bonuses in the form of 401(k) profit-sharing contributions, you can assess exactly what you can afford and make the contribution any time before the tax filing deadline – including any extensions you choose to take. Doing so also maintains the ability to deduct the contribution on the previous year’s tax return.
Plans allow contribution vesting
Looking for valuable recruitment tools? Look at bonuses and 401(k) plans. If structured to vest with the employee’s tenure, they can also act as powerful retention tools. Employees considering leaving in a short time frame will lose any portion that has not yet been vested.
Build it into your existing 401(k) plan with no additional work
Signing your company up for a 401(k) plan takes time and effort, but once in place, you can easily add a profit-sharing plan. Many retirement plan providers will also add the program without charging an additional fee.
Disadvantages of These Plans
As much as our country favors 401(k) plans, including those that incorporate profit-sharing plans, there are a few things that need to be kept in mind.
- There are limits to how much can be contributed for each employee. The total of employee deferrals and employer deposits cannot be greater than 100% of the employee’s compensation.
- Limits exist as to how much you can contribute for any employee a year. In 2021 that limit is $58,000, or $64,500 for employees over the age of 50.
- Employer contributions may also be limited by an employee’s annual compensation. For 2021, no contributions were allowed for employees earning more than $290,000.
- Only contributions of up to 25% of total employee compensation can be deducted by employers.
Acknowledging the contributions that your employees make is an integral part of keeping your workforce morale upbeat. Also, profit sharing is a powerful tool in support of that goal. Do you have questions about how to approach 401(k) profit sharing for your business? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.