Choosing a Retirement Plan: Profit-Sharing Plan

Highlights:

Guess what. You don’t need profits in order to make contributions to a profit-sharing plan. Of course, having a profit would probably make it easier to actually contribute something.

Contributions to a profit-sharing plan are discretionary. There is no set amount that you need to make. If you can afford to make some amount of contributions to the plan, then go ahead.

If you do make contributions, you will need to have a set formula for determining how the contributions are divided. This money goes into a separate account for each employee.

One common method for determining each participant’s allocation in a profit-sharing plan is the “comp-to comp” method. Under this method, the employer calculates the sum of all of its employees’ compensation (the total “comp”). To determine each employee’s allocation of the employer’s contribution, you divide the employee’s compensation (employee “comp”) by the total comp. You then multiply each employee’s fraction by the amount of the employer contribution. Using this method will get you each employee’s share of the employer contribution.

If you establish a profit-sharing plan, you:

  • Can have other retirement plans.
  • Can be a business of any size.
  • Need to annually file a Form 5500.

As with 401(k) plans, you can make a profit-sharing plan as simple or as complex as you want to. Pre-approved profit-sharing plans are available to cut down on administrative headaches.

Information List:

Pros and Cons:

  • Greater flexibility in contributions – contributions are strictly discretionary.
  • Good plan if cash flow is an issue.
  • Administrative costs may be higher than under more basic arrangements.
  • Need to test that benefits do not discriminate in favor of the highly compensated employees.

Who Contributes: Employer contributions only.

Contribution Limits: The lesser of 25% of compensation or $46,000 in 2008 ($49,000 in 2009 and subject to cost-of-living adjustments for later years).

Filing Requirements: Annual filing of Form 5500 is required.

Participant Loans: Permitted.

In-Service Withdrawals: Yes, but subject to possible 10% penalty if under age 59-1/2.

Source: http://www.irs.gov/retirement/article/0,,id=108948,00.html

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