Profit Sharing Plans Flashcards
7 Types of Profit Sharing Plan
- Profit Sharing Plans
- Stock Bonus Plans
- Employee Stock Ownership Plans (ESOP/LESOP)
- 401(k) Plans with either Profit Sharing or Stock Bonus
- Thrift Plans -Age Based Profit Sharing Plans
- -New Comparability Plans
Tip: Know the 7 types
Is a profit-sharing plan the same as a 401K Plan?
No. Key difference is only employer can make contributions to a profit sharing plan.
True/False: All profit sharing plans are defined contribution plans?
True
Characteristics of Profit Sharing Plans
- All profit sharing plans are defined contribution plans.
- All profit sharing plans are established and maintained by an employer.
- All profit sharing plans provide for employee participation in profits.
- All profit sharing plans utilize a definite predetermined formula for allocating the contributions to the plan. Contributions must be nondiscriminatory.
- All profit sharing plans are either noncontributory or contributory or contributory
- Noncontributory: Employee does not contribute to the plan and all contributions to the plan are from the employer. Contributory: Employee contributes to the plan (CODA (Cash or Deferred Arrangement) plan).
Tip: Must Know
Contributions and Deductions for Profit Sharing Plans
- Contributions must be made by the due date of the company’s income tax return including any extensions.
- Contributions are discretionary, but must be “substantial and recurring.”
- No requirement of company profit for a contribution to be made.
- Employer Contributions are limited to 25% of total employer covered compensation. Contributions are limited to the lesser of 100% of compensation, or $61,000 for 2022 per employee, per year.
While plan sponsors aren’t required to make contributions to their profit sharing/401(k) plan every year, contributions must be “recurring and substantial” for a plan to be considered ongoing.
Employer Contribution Limits - 25%
Contributions
An employer’s maximum deduction is limited to 25% of the annual compensation paid to eligible employees. The individual maximum contribution limits for employees applied to all defined contribution plans are the lesser of 100% of compensation or $61,000 whichever is less. Depending on the allocation formula in a profit sharing plan, the contributions for individual employees may exceed the 25% level as long as the aggregated employer contribution does not exceed the 25% maximum employer contribution limit.
Ex: If an employer pays $1,000,000 in compensation to its workers, then the employer may deduct at most $250,000 in DC plan contributions.
The 25% limit is an aggregate limit for the whole plan. Individual employees are not necessarily limited to 25% of pay. Some may receive more, some less, so long as the overall employer contribution deducted does not exceed 25% of the total paid to all those benefitting.
The deductible limit is for employer contributions, so an employee’s salary deferrals do not count toward the 25% limit.
Can all profit sharing plans be social security integrated?
No. Cannot integrate any employee plans ( like simple, 401k, plans) and can almost always integreate all employer plans (but cannot integrate ESOP)
Options for Allocation of Contributions
-Standard Allocation
*use for small biz owners who employees and himself are roughly same age and they all make roughyl the same
amount of $
-social security integration
*use for small biz owners whose employees and himself are roughly same age, but he makes alkot more money than
them
-Age-Based Profit Sharing Plans (increases contributions to plans for those who are closest to retirement)
*use for small biz owners who are older
New Comparability Plan
Contribution dependent upon employee classification.
-Owner
-Long time employee (10 years)
-Rank-and-File
Designed to skew benefits towards owner classification.
IRC states that “either contributions or benefits must not be discriminatory…”
Plan must generally pass one of two minimum allocation gateways:
NHCE allocation rate is at least 1/3 of the HCE with the highest allocation rate, or
Each NHCE receives an allocation of at least 5%
Cash or Deferred Arrangements (CODA) - 401(k)
This is the most prevalent type of plan established today.
They are predominantly funded by employee deferral contributions.
This plan attaches to a qualified plan.
It permits employees to defer compensation to a qualified plan
It permits employees to defer compensation to a qualified plan.
Deferrals are limited to $20,500 for 2022 per year, or $27,000 for those age 50 and over.
Employers may (but are not required to) match the employee’s deferral.
Tip: The deferral limit is a per person per year limit which aggregates deferrals from 401(k), 403(b), SIMPLEs, and SARSEPs. 457 plans have a separate deferral limit. (If you have multiple employers, you are still limited to an overall deferral of $20,500 across the plans)
Vesting for 401(k)
- Eligibility - 21 and 1 year rule. Employees are eligible who are age 21 and have one year of service (1,000 hours worked during one plan year).
- Under the new rules, long-term, part-time employees who work at least 500 hours in three consecutive years (and have attained age 21) must be allowed to participate in 401(k) plans.
- Vesting
- Employee deferral contributions:
- Vested 100% at all times
- Employee deferral contributions:
- Employer matching contributions:
- Must vest at least as rapidly as:
- 2 to 6 graduated or 3-year cliff
- Must vest at least as rapidly as:
Contributions to CODAS (401ks)
Employee Contributions:
- Elective deferral contributions:
- Limited to $20,500 for 2022 per year.
- Additional $6,500 for age 50 and older, which is called the “catchup amount.”
- Deferral contributions are subject to payroll taxes.
- Limited to $20,500 for 2022 per year.
- After-tax contributions are available through a Thrift Plan and Roth 401(k)
- Post tax are allowed after 2005 if Plan adopts a Roth deferral provision (to be covered later).
Tip: CODAs are not permitted to use Social Security integration; however the profit sharing portion of a 401(k) plan may use integration - just the deferral arrangement portion cannot.
Roth IRA vs. Roth 401k
PSP Non-Discrimination Testing
- Benefits must be provided to a certain percentage of rank-and-file employees.
- Negative Elections: the employee is deemed to have elected a specific employee deferral unless the employee elects out.
- Nondiscrimination testing includes:
- Actual Deferral Percentage Test (ADP Test)
- Actual Contribution Percentage Test (ACP Test)
Who is a highly compensated employee? (for purposes of ADP/ACP testing and safe harbor/ratio % and average benefits test)
