What Are My Retirement Plan Design Options? Part One: Profit Sharing
Whether you already have a retirement plan or you are thinking of adding one to your business, knowing your plan design options will make sure you're maximizing every benefit. I have talked about cash balance plans before. But over the next couple of months I will breakdown all the options for defined contribution retirement plans. Going through the various plan options available to plan sponsors and giving examples of how they work in the real world. This will help give business owners and their employees the information needed to match their plan design to their actual needs.
WHICH RETIREMENT PLAN OPTIONS IS RIGHT FOR YOU?
Minimize Cost | Attract and Retain Employees | Maximize Tax Benefits | |||||||||
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DEFINED CONTRIBUTION PLANS
A defined contribution plan is a retirement savings vehicle that lets employees, and sometimes their employers, contribute to a tax-advantaged retirement account. In most plans, contributions help lower taxable income and growth in the account are tax-free until the money is withdrawn. There are also Roth contributions available in most plans that can grow and be withdrawn tax free. In all defined contribution plans, investment risks and the potential for gain are borne by the participating employee, not the employer. Though some employers offer matching contributions to encourage workers to contribute to the plan, the ultimate decision to save rests with the employee. Employees have substantial control over how the contributions to their plan are invested and may generally choose from an assortment of investment options allowing for diversification. Examples of defined contribution plan options and features include profit sharing employer contributions, 401(k) employee deferrals, Safe Harbor contributions, and Social Security Integration.
Profit Sharing Plan
The first plan type that we will cover today is a Profit Sharing Plan. These types of plans are typically used when companies seek to maintain flexibility in making contributions. These Plans are funded by the business as tax-deductible contributions. The contributions can be discretionary and are generally not required every year. This is especially important in today's employment environment. As a business owner you may not want to commit to a pay raise across the board. Instead, make a payment to their profit sharing plan as a way to reward your employees. To further maintain some control on the contributions, plan sponsors can subject employees to a vesting schedule. All contributions are based on a flat percentage of salary for all eligible employees.
Below is an example of a business owner who wants to maximize their deferral. The 2 owners put in $103,000 into the profit sharing plan for themselves, which equates to 20% of their eligible compensation. They now have to give a 20% contribution based all other employee's eligible compensation. Based on their employee's compensation, their employee's total contributions would be $40,000. And remember these contributions are tax-deductible. Not a bad deal!
DEMOGRAPHICS | CONTRIBUTIONS | ||||||||||||||||||||||||||||||||||||
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While is this a good retirement vehicle, there are some limitations and it's not very targeted. But it's the backbone that all other retirement plans are built on. And for getting in maximum contributions and rewarding your employees, it's great. In our next plan design post I will cover the 401(k) option, which addresses some of the profit sharing plan's limitations.
Questions about your plan design? Let's chat.
The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.