Deciding on a profit sharing formula

One of the biggest decisions a plan sponsor must make in terms of their retirement plan is the profit sharing allocation formula that satisfies their goals and needs. An employer may make a discretionary profit sharing contribution on behalf of eligible employees based on compensation. There are several options to consider with regard to the allocation of profit sharing contributions, and below you may access examples of four different formulas:

Download Examples

Illustration #1:  Pro-rata allocation. Each employee would receive the same percentage of compensation as a profit sharing contribution.

Illustration #2:  Integrated allocation. This traditional profit sharing formula allows a higher contribution to be allocated to employees with compensation above a specified integration level, most commonly based on the social security taxable wage base.  There is a small amount of flexibility in the allocation formula, as defined by the IRS.

Illustration #3:  New comparability allocation (cross-tested). This formula allows a company to deposit different levels of contributions for different employees. This option allows the most potential flexibility in structuring the allocation. There are required tests, and employees may need to given a minimum contribution to satisfy the complicated testing.

Illustration #4:  New comparability allocation combined with a safe harbor 401(k) plan. This is similar to Illustration #3, but demonstrates how to combine this type of profit sharing allocation with a safe harbor 401(k) plan. This is often the design of choice for many small to medium size employers, as company owners are often able to maximize their own personal contributions at the least employer expense for staff contributions.

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