Is 401(k) Profit Sharing Right for Your Company?
Profit-sharing plans are a unique type of retirement plan in which employers can choose how much of the company’s profits to share with employees each year in their retirement accounts. At the end of each year, a business can evaluate its overall profits and set aside a portion of its pre-tax profits to share. The total amount can vary each year and they can even decide if they would like to contribute at all.
The business owners can choose to award the money as a percentage of the employee’s salary OR as a flat dollar amount. In 2020, the yearly contribution limit in a profit-sharing plan $57,000 (for those under 50), which is much higher than a traditional 401(k) plan of $19,500.
Small businesses choose to add profit sharing plans to their 401(k) for two main reasons: first, they want to contribute to employee retirement accounts, but they also want to reduce the tax burden on the company.
Why do employers like 401(k) Profit Sharing?
- The employer controls the overall cost – the amount they contribute annually is totally up to them.
- They can use it to attract and retain employees – a company can use profit sharing as an added incentive for employees to join the firm. They can also put a vesting requirement (such as employees have to have work at the company for one or two years) to aid in retention efforts.
- Companies can also reduce their overall business tax liability. As with your 401(k) employer contributions, all of a company’s profit-sharing contributions are tax deductible.
Why do employees like 401(k) Profit Sharing?
- It helps them turbo-charge their retirement: the extra amount they receive is above and beyond what they save each year in their standalone 401(k).
- Employees could still receive the profit sharing even if they aren’t contributing anything to their 401(k). This is different than having to contribute to get an employer match.
- The limits are also higher than a standalone 401(k) – this is especially enticing to employees of companies (especially owners) who are getting closer to retirement and want to start socking away more.
Overall, more money tends to make employees happier. Happy employees tend to stay with the company longer. Profit-sharing can be a win/win for employees and employers in small and large companies (and, ironically, non-profit companies can also take advantage of this type of plan).