Profit Sharing Plans

                       The Traditional Plan 
               The Social Security Integrated Plan 
               The Age Weighted Plan 
                                          The New Comparability Plan 



                                                             Traditional Profit Sharing Plans

Profit sharing plans were created to allow business owners to make discretionary retirement plan contributions on behalf of their employees. The premise behind these contributions was to reward employees for their contribution to the profits of the company.The contributions are generally stated as a percentage of payroll and are not taxable to employees when made.

Additional profit sharing plan features:

1.Only a business owner can establish a profit sharing plan.
2.The 2006 maximum employer contribution limit is 25% of eligible payroll.
3.The maximum allocation per participant is the lesser of $44,000 or 100% of eligible compensation. Special calculations apply to sole proprietors and partnerships.
4.The interplay between the 25% of payroll deductibility of the profit sharing contribution and the maximum limit of the contribution of $44,000 or 100% of compensation per participant will cause the contributions to be substantially lower than that allowed.
5.Any type of company can adopt a profit sharing plan including non-profit businesses.
6.Company contributions are discretionary, flexible and can be changed from year to year.
7.The contributions can be made subject to profitability or not 8.Profit sharing contributions are tax deductible.
9.Profit sharing plans may require vesting.
10.Loans and hardship withdrawals may be made available. 11.Company contributions are non-taxable when made for the employee and grow tax-deferred until removed.
12.Can be combined with a 401(k) plan
13.Minimum distributions are required, but may be delayed until retirement.
14.Distributions are taxable and may be subject to penalty taxes when taken before age 59½.

              
  Integrated Profit Sharing Plans







Traditionally, an employer would choose either one of two allocation formulas for his or her plan.

The first method would be to allocate the contribution in proportion to pay. Thus, if the contribution percentage equaled 10% of pay, then each participant would receive a contribution equal to 10% of his or her pay.

The second method would be to use a formula that was integrated with Social Security. Social Security is discriminatory and favors employees with compensation below the Social Security taxable wage base ($94,500 in 2006). This is so because both the company's contribution to Social Security and the Social Security benefit represent a higher percentage of a lower-paid employee's compensation than the percentage for a higher-paid employee.

The Internal Revenue Code and the Intenal Revenue Services' regulations permit the company to offset the effect of this discrimination against the higher-paid employees by integrating the plan with Social Security.

In the resulting integrated plan, the employer will provide, through combined profit-sharing and Social Security contributions, the same (or more similar) overall percentage-of-pay contributions for higher-compensated and lower-compensated participants.

Thus, if a contribution of10% of pay is made to the plan, then using an "integrated" formula, an owner or executive earning $150,000 a year would receive an allocation of 10.6% of pay or $15,849. This contrasts with an employee earning $30,000 who would receive an allocation of only 7.2% of pay or $2,151. 

                                             BACK TO TOP

Age Weighted Profit Sharing Plans for older owners and shareholders

   The next step in the evolution of profit-sharing plans was to create
age-weighted allocation formulas. Based on the principle used to fund a defined-benefit plan, a higher allocation percentage can becontributed on behalf of an older participant to compensate for the fact that the contributions made on his behalf will have less years to accumulate investment earnings to retirement than the contributions made for a younger participant.

   For example, consider a profit-sharing plan with a normal retirement age of 65 and two participants, one age 55 and the other age 35. the contribution for the 55-year-old participant is based on a funding period of 10 years (65 minus 55), whereas the contribution for the 35- year old is based on a 30-year funding period (65 minus 35).
Accordingly, and ignoring interest, the contribution for the 55-year old would be three times (30/10) as great as the contribution for the 35- year old to accumulate to the same amount. By discounting for assumed investment earnings and because of compound interest, the allocation percentage for a 55-year old participant is more than twice as great as that of a 45-year old and is more than five times as great as the allocation percentage of a 35-year old. 


                                                BACK TO TOP

                New Comparability Plans





On On October 20, 2005, the IRS announced the 2006-dollar limits on compensation and benefits for qualified retirement plans and the new Social Security Taxable Wage Base.

For the small business owner, these changes provide the opportunity for increased contributions to the plan while maintaining or decreasing the overall contribution expense of the plan. If this statement seems too good to be true, it may be to those small employers not taking advantage of the currently available plan design, benefits and features of the new comparability plan.

The cost to provide a benefit of $1 per month at age 65 is much greater for older employees than it is for a 25 year old. Using actuarial assumptions permissible under the 401(a)(4) regulation, the cost of providing a benefit of $100 per month payable at age 65 is $4,200 for a 55-year-old compared to $363 for a 25-year-old.

Therefore, assuming their salaries were equivalent, a $4,200 profit sharing contribution to a 55-year-old could be proven equivalent to a $363 contribution to a 25-year-old.

Look at the typical Example:

Tom Williams has a small business and wants to start planning for retirement. His primary objective is to contribute the maximum amount possible for himself with the lowest overall cost of the plan.
The following example indicates the retirement tax savings available to the owner under the Integrated, New Comparability and Ultra Comparability 401(k) formulas.


To see a comparison of plan benefits based on your company’s demographics, call Coastal Pension Consultants, Inc. at 727-781-0817.


                                                                     back to top