Types of Plans
• Profit Sharing
A traditional 401(k) Plan allows participants to contribute money for retirement on a pre-tax basis. The amount the highly paid employees (those earning more than $120,000 and who own more than 5%) can defer from salary is based on what the employees contribute to the plan. The maximum employee contribution for 2017 is $18,000 ($24,000 for those 50 and over), while the maximum allowed for all contributions is $54,000 ($60,000 for those 50 and over) Each plan has eligibility requirements that dictate when employees can begin making contributions to the plan. Employer contributions are made in the form of a matching contribution, a profit sharing contribution or both. The amount depends on the demographics of a company and the company’s budget. A profit sharing contribution is usually used to maximize the benefit to the owners. The profit sharing can be based on compensation, age, years of service or job classification, if the demographics favor this. The average matching contribution is 50% up to 6%. The match and profit sharing can be subject to a vesting schedule based on years of service.
PROFIT SHARING PLAN
A profit sharing plan is much more flexible than a SEP or SIMPLE IRA. This plan consists of only employer contributions, but can have a vesting schedule. Contributions are flexible and are not required each year. This vesting schedule can be graded over as much as a 7-year period. This schedule is intended to keep employees longer knowing that if they leave within the 7 years, they will lose a percentage of their account balance. Another big advantage of this type of plan is that the contribution can be based on age, years of service or job classification if the employee demographics favor this (SEE New Comparability formula below). To achieve this flexibility, this type of plan requires an administrative firm to perform all administrative duties and government tax filings.
SAFE HARBOR 401(K) PLAN
In traditional 401(k) plans, what the highly paid employees can contribute to the plan is based on what the employees contribute. Therefore, if the employees do not contribute very much, then the highly paid are very limited in their contributions. Also, if the highly paid contribute too much in relation to the employees, then the highly paid will receive refunds at the end of the year. Adding a Safe Harbor contribution to the plan allows the highly paid to contribute the maximum regardless of what the employees contribute. There are two Safe Harbor contributions that qualify. The first is the Safe Harbor match which is 100% on the first 3% plus 50% on the next 2%. This means if an employee contributes 5%, they will receive a 4% match. If they contribute nothing, they do not receive a match. The other is a 3% of salary contribution that goes to all eligible employees, whether they contribute to the plan or not. Also, the Safe Harbor contribution is 100% vested immediately.
A New Comparability formula can be used in any 401(k) or Profit Sharing Plan. This formula allows you to establish separate classes of employees for which you provide different contribution percentages. The classes must be defined in the plan’s document, but the contribution percentages can be decided on at the end of each plan year. This allows you to allocate one percentage to the highly paid and one to the employees. The amount the highly paid can receive in relation to the employees is dependent on the age of employees in each group and the contribution percentages. If you have an older highly paid group, the better it works. This formula can also be used if you wish to give different percentages to different classifications of employees (i.e. owners, administrative staff, regular staff, middle management, etc.).
Companies that establish 403(b) plans are either tax exempt or government entities. This plan is very similar to 401(k) plans, but are not subject to some of the non-discrimination rules under the Internal Revenue Code. In a 403(b), the contribution limits are pretty much the same as a 401(k) plan. Many tax-exempt companies are now using 401(k)’s instead of a 403(b).