Profit Sharing Plans Chapter 17 Employee Benefit Retirement

Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning What is it? A profit sharing plan is a defined contribution plan featuring a flexible employer contribution provision – Contribution can be a purely discretionary amount or based on some type of formula – Employer contributions allocated to individual accounts of participants on nondiscriminatory basis – Plan benefits consist of the amount accumulated in each participant’s account at retirement or termination – Plan benefits usually distributed in a lump sum at termination Copyright 2009, The National Underwriter Company 1

Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning When is its use indicated? • When employer’s profits varies from year to year • When employer wants an incentive feature • When employee group is – Relatively young – Willing to accept a degree of investment risk • When employer wants to supplement an existing defined benefit plan Copyright 2009, The National Underwriter Company 2

Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Advantages • Maximum contribution flexibility for employer • Contributions can be made even if no profits • Provides a tax-deferred retirement savings medium for employees • Participants can benefit from good investment results Copyright 2009, The National Underwriter Company 3

Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Disadvantages • Retirement benefits may be inadequate for employees entering the plan at later ages • Relative amount of plan funding available for highly compensated employees is more limited • Employees bear investment risk under the plan • Level of employer funding less predictable Copyright 2009, The National Underwriter Company 4

Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Design Features • Discretionary contribution provision – Employer can determine amount each year – Employer can omit contribution in a given year – But, IRS regulations require contributions to be “substantial and recurring” • Formula provision – Specified amount contributed each year – “Profits” may be defined as specified by employer – Possibly can include a “fail-safe” provision Copyright 2009, The National Underwriter Company 5

Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Design Features • All plans must have formula for allocating employer contributions to participant accounts – Cannot discriminate in favor of highly compensated employees – “Compensation” must be defined in nondiscriminatory way – Amount of compensation taken into account is limited – Can be based on compensation or years of service, integrated with Social Security Copyright 2009, The National Underwriter Company 6

Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Design Features • Vesting provisions – Any vesting provision permitted by Code can be used in general – Special vesting requirements for “matching contributions” – Forfeitures (non-vested amounts “forfeited” upon leaving early) usually added to remaining participants’ accounts – Formula for allocating forfeitures usually same as that used for allocating employer contributions Copyright 2009, The National Underwriter Company 7

Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Design Features • Distribution provisions – Benefits usually payable at termination of employment or at plan’s stated “normal retirement date” – Payable in a lump sum or a series of installment payments – Generally allow “in-service” distributions (benefits payable before termination of service) – Funds available for “in-service” distributions must be vested and must have been in the plan at least 2 years – 10% early distribution penalty may apply to distributions prior to age 59 -1/2 Copyright 2009, The National Underwriter Company 8

Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Tax Implications • Employer contributions deductible when made • Maximum deductible employer contribution may not exceed 25% of the payroll of all employees covered under the plan • IRC Section 415 limits the “annual additions” (employer contributions, forfeitures form other participant’s accounts, and employee contributions) Copyright 2009, The National Underwriter Company 9

Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Tax Implications • Taxation of employees deferred until amounts withdrawn • Lump sum distributions may be eligible for 10 -year averaging for employees born before 1936 • Plan subject to ERISA reporting and disclosure rules Copyright 2009, The National Underwriter Company 10

Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Alternatives • Money purchase pension plans (no employer contribution flexibility) • Cross-tested, age-weighted and target plans (more favorable for older employees; discussed later) • Defined benefit plans (provide more security; more complex and costly) • Nonqualified deferred compensation plans Copyright 2009, The National Underwriter Company 11