Welcome to the introductory segment of our Profit-Sharing Plan series! In this session, we’ll delve into the fundamentals of Profit-Sharing Plans and how they can be advantageous for both business owners and employees.
A Profit-Sharing Plan operates under the umbrella of Defined Contribution (DC) plans, relying on employer contributions to bolster employees’ retirement accounts. Business owners, seeking to establish a profit-sharing plan for themselves and their workforce, can make substantial contributions that are not only tax-deductible but also foster tax-deferred growth.
Let’s explore the key aspects of Profit-Sharing Plans with a focus on their retirement savings facet. Picture a 401(k) without the employee’s deferred salary aspect – that’s essentially a profit-sharing plan. Employers initiate and voluntarily contribute to employees’ retirement accounts, utilizing profits generated by the business. These contributions grow tax-deferred, and taxation only occurs when employees start receiving distributions in retirement.
Understanding the rules of Profit-Sharing Plans is crucial. Unlike some other retirement plans, employees don’t contribute to profit-sharing plans; instead, employers establish, manage, and fund these plans on behalf of their employees. Due to the complexity and need for IRS compliance, many business owners opt to enlist the services of a third-party administrator.
While employers can decide yearly whether to contribute, they must ensure that their contributions do not favor management over rank-and-file employees to maintain fairness. Non-discrimination audits may apply to profit-sharing plans, encouraging employers to adopt formulas for shared benefits that circumvent any appearance of bias.
Employee benefits within profit-sharing plans are subject to IRS rules, discouraging early withdrawals with a 10% penalty for distributions before age 59.5. The treatment of benefits when an employee leaves the company before retirement age varies across plans.
Profit-Sharing Plans offer attractive contribution limits set by the IRS. The annual limit, for 2020, is the lesser of 100% of the participant’s compensation or $57,000. This high limit makes profit-sharing plans an excellent choice for older workers and business owners looking to make substantial contributions for retirement.
Stay tuned for part two of our Profit-Sharing Plan series, where we will delve deeper into the intricacies of these plans. For a more personalized approach to your financial situation, consider consulting with a financial advisor for long-term advice tailored to your unique needs.
About Pathfinder Retirement:
At Pathfinder Retirement, our mission is to guide individuals in achieving their retirement aspirations. Through our extensive video resources, we empower individuals to explore various financial and retirement planning topics. Tailored to federal employees, our videos cover critical aspects such as FERS retirement annuity, creditable service, and retirement group deductions. Additionally, we provide insights into different retirement plans, including pension plans, cash balance plans, and 403(b) and 457 plans, offering valuable perspectives on their distinctions and associated risks.