How to Start a Profit-Sharing Plan

Are you looking for a way to attract new talent, increase workplace morale and help your employees save for retirement? Then a profit-sharing plan may be the right choice for your business. Profit-sharing plans are essentially retirement plans that give employees a certain share of the company’s profits. There is no set amount of contributions that an employer must pay out to its employees, giving businesses more control over their finances. However, starting this process does involve a series of important steps that must be followed accurately to ensure a satisfactory outcome.

What Does a Profit-Sharing Plan Mean?

Also referred to as a Defined Contribution (DC) plan, profit sharing relies on employer contributions made to employee accounts. When a business chooses to participate in a profit-sharing program, the business owner agrees to make generous contributions that offer tax-deferred growth and are tax-deductible. Profit sharing plans can be either contributions made to tax-advantaged retirement accounts or cash bonuses.

Getting Started

Before an employer can get started on a profit-sharing plan, he or she must first set up an official plan document similar to a 401(k). According to the Department of Labor, an employer interested in starting a profit-sharing plan must adopt a written plan document, set up a trust for the plan’s assets and develop some sort of record-keeping system. In addition, the business must provide eligible employees with plan information.

Make a Planning Document

A written plan document serves as the foundation for your business’s day-to-day operations. As you will ultimately be bound by the terms of the plan document, you will want to request assistance from a professional who is knowledgeable in employee retirement plans. Your plan document will include a variety of information, including how contributions will be allocated to employee accounts.

Create a Trust to Hold Assets

The assets of a profit-sharing plan must be held in a trust to ensure that these assets are only used to benefit the plan’s participants and their beneficiaries. Your business will need to appoint at least one trustee to handle all plan investments, contributions and distributions. As the trustee will be responsible for the financial integrity of the plan, be sure that this job is given to someone you can trust.

Implement a System of Keeping Records

Accurate record keeping is essential for businesses participating in profit-sharing plans. Record-keeping is needed to properly track and attribute contributions, plan investments, earnings, losses, expenses and distributions. Having concise records also helps business owners retain the data they need to prepare the plan’s annual return that must be filed with the federal government.

Inform Eligible Employees of Plan Details

Business owners are also responsible for informing eligible employees of the details surrounding the profit-sharing plan. This includes the plan’s benefits, features and rights. All eligible participants must also be provided with a Summary Plan Description (SPD). This plan document will contain the plan summary that describes how the plan operates.

Requirements for Profit-Sharing Plans

When you start a profit-sharing plan, you will have many decisions to make. First, you will need to decide whether you want to manage the plan yourself or hire a professional to do it for you. Proper management consists of many elements, such as participation, vesting, contributions, nondiscrimination, investing, reporting, distributing and fiduciary responsibilities.

Eligibility

Eligibility for a profit-sharing plan can differ from company to company. However, most follow the same basic rules. In some cases, employees may not be eligible to participate if they are under 21 years of age, are nonresident aliens, have completed less than one year of service or are covered by a collective bargaining agreement that does not include plan participation.

Business Responsibilities

When starting a profit-sharing plan, businesses welcome certain responsibilities. First, a business must act solely in the interest of the plan’s participants and their beneficiaries. Next, a business must carry out all duties with skill, care and diligence. Finally, the business must follow all plan documents and attempt to diversify all plan investments.

Limitations of Profit-Sharing Plans

While profit-sharing plans can be highly advantageous, they do present certain limitations. For example, employers can only deduct contributions of up to 25 percent of the total employee compensation. In addition, total contributions per employee may not exceed 100 percent of the employee’s compensation. In 2020, annual compensation of up to $285,000 can be used to calculate an employer’s contribution.

Contact JMG for Help Starting Your Profit-Sharing Plan

A profit-sharing plan can be an excellent way for business owners to help their employees save for retirement. Of course, starting this process can often be confusing. For more information or for help starting your own profit-sharing plan, contact the experts at John M Glover.