Profit-sharing plans offer employers both design flexibility and discretion when making contributions.
How Do Profit-Sharing Plans Work?
Employer contributions are self-determined and can be allocated in a number of ways. If an employer makes little or no profit during a year, no contribution is required, although low profits don’t restrict the contribution level and an employer is permitted to make contributions even if the company has no profit.
Profit-Sharing Plan Eligibility
Typically, a profit-sharing plan’s eligibility provisions require employees to have one year of service and be at least 21 years of age. A two-year service period may be imposed if full immediate vesting is provided. For most plans, a year of service is defined as working 1,000 hours in a plan year.
Profit-Sharing Plan Contributions
An employer’s maximum deduction is limited to 25% of the annual compensation paid to eligible employees. The individual maximum contribution limit for employees applied to all defined contribution plans is 100% of compensation or $66,000 for 2023, whichever is less. Depending on the plan’s allocation formula, contributions for individual employees may exceed 25% providing the aggregated employer contribution does not exceed the 25% employer contribution limit.
Advantages of a Profit-Sharing Plan
- Self-determined employer contributions have built-in flexibility and can be allocated in a wide variety of ways.
- Employers can make discretionary contributions each year, which can be subject to a vesting schedule.
- A profit-sharing plan may be integrated with Social Security or may use a specific allocation method.