PROFIT SHARING PLANS

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PROFIT SHARING, money purchase, and other types of defined contribution (DC) plans can take the form of IRS pre-approved designs, or other designs that meet the employer’s objectives while still complying with IRS rules.

Pre-approved methods of allocating employer contributions include:

  • a level percentage of pay for each employee, and
  • an “integrated” plan that takes the employer’s FICA taxes into account by allocating an additional contribution for pay above the Social Security wage base.

Many other designs are possible when pre-approved plans aren’t good enough. Two examples are shown here:

  • A service-weighted plan that contributes a higher percentage of pay for each year an employee stays with the company. Service-Weighted plan allocates 1% of pay per year of service.
  • A “class allocation” plan that enables highly paid employees to defer more of their compensation while other employees take most of their compensation in cash. Class Allocation plan allocates 20% of pay for owner, 5% for employees.

Both of these examples are “cross-tested” plans, named after the IRS “cross-testing” process of converting contributions into benefits for nondiscrimination testing.

 

Age

Years of Service Pay Service-Weighted Class Allocation

Contribution

% of Pay Contribution

% of Pay

Owner

55 20 $250,000 $50,000 20.0% $50,000 20.0%

Employee

40 10 50,000 5,000 10.0% 2,500

5.0%

Employee

30 5 30,000 1,500 5.0% 1,500

5.0%

Total

$330,000   $56,500 17.1% $54,000

16.4%

You can follow current defined contribution topics on the DC plan section of our blog.

© 2012 Northern Consulting Actuaries, Inc. dba Van Iwaarden Associates.