Profit Sharing Plans

Profit Sharing Overview

Profit sharing plans are put in place to give employees a sense of ownership, or vested interest, in the company by allowing them to share in the profits of the company and also to help them increase their retirement funds. Even if a corporation decides to take part in a profit sharing, it is not mandatory that they contribute to the plan; it is at the sole discretion of the company. Secondly, conventional thinking would have us believe that profit sharing plans are only paid out when a company makes a profit. This is also not always the case, a company may elect to contribute to the plan even in a loss scenario.

Typically, employers will require that you be an employee for 2 years before they allow participation in a profit sharing plan. Companies may elect to fund the profit sharing distribution in a couple ways; same percentage to each employee, or make it age weighted. In either case, the maximum allowable contribution is 25% of the employee's income up to a maximum dollar amount of $45,000 per year. This rule allows a greater distribution for those who are older than 50 years and contribute to a 401k plan.

Not only is there a yearly cap on profit sharing but there is a maximum lifetime cap of $225,000, which can be adjusted higher due to inflationary pressures.

Exclusions

There are a few exclusions to the population of workers who are allowed to participate in profit sharing plans; those are union workers and non-resident aliens that have no U.S. source of income.

Vesting

Vesting is different from one employer to the next but the most common schedule allows for 20% vesting each year, starting in the second year.  This type of vesting is referred to as graded vesting and is applicable to employees with less than 1 year of service.

If the company requires that you be with them for at least 1 year, then your allocation will vest 100% after you become part of the profit sharing plan.

Benefits of Profit Sharing

The key benefit in profit sharing, for both the employer and employee, is the tax advantage that is gained. Employers can take the profit sharing allocation as a tax deduction while employees can grow their profit sharing accounts tax free until they are withdrawn.

Penalties

Being that profit sharing is meant to be a longer term retirement planning vehicle, there is a 10% early withdrawal penalty for participants who are under the age of 59 and a half.


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