1 min read

Understanding Integrated Profit Sharing Contributions in a 401(k) Plan

Profit sharing contributions in a 401(k) plan have become a popular method for businesses to incentivize employees and promote long-term savings. Unlike what the name suggests, profit sharing doesn't necessarily involve sharing your company's profits. Instead, it refers to pre-tax contributions that employers can make to their employees' retirement accounts at the end of the year, offering numerous tax benefits.

Understanding Integrated Profit Sharing:
Adding an integrated profit sharing element in a 401(k) plan offers flexibility that allows businesses to maximise benefits for their highly compensated employees. This specialized contribution, called the integration level, is usually determined as a percentage—in many cases around 5.7%— of the compensation earned.

This percentage influences how the profit sharing is distributed among employees, taking into consideration other factors such as elective deferrals, catch-up contributions for older employees, and safe harbor contributions. These variables can influence the total integrated profit sharing contribution for each employee, and therefore, should be taken into account when calculating the final contribution.

Profit Sharing Plans Benefits for Businesses:
1. Bonus with Tax Benefits: The contributions made under profit sharing plans boost employees' retirement savings without increasing their taxable income.
2. Flexibility: Profit sharing allows businesses to decide the contribution after the year end, giving them flexibility to plan their finances.
3. Reward can Vest Over Time: Companies can establish a vesting schedule for their employees where employees receive more contributions the longer they stay.
4. Profit sharing contributions are not counted towards the IRS annual deferral limit.
5. No Extra Work: If you already offer a 401(k) plan, adding a profit sharing component involves little extra management.

Allocating Contributions:
When making a contribution to your profit sharing plan, you allocate a “pool” of money to be shared among all eligible employees. You can use a flat dollar amount method, where each employee receives the same contribution, or a pro-rata method, where contributions are made based on employees’ relative salaries.

A third approach is the 'New comparability' model that allows for a greater disparity in contributions, benefiting older employees with higher salaries. This method requires passing IRS testing to prove non-discrimination.

In essence, calculating integrated profit sharing in a 401(k) plan requires understanding employee demographics, total compensation, and pre-determined contribution rates. By leveraging this understanding, businesses can structure retirement benefits that support their strategic goals and benefit their diverse workforce.