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How Does 401k Profit Sharing Work?

When it comes to offering retirement benefits to your employees, you have more options than just offering a 401k. So, how does profit sharing work?

Profit sharing can be a great option for employers who want to give their employees a little extra towards retirement, help save more towards your own retirement, or would simply would rather give money to their employees than Uncle Sam.

It’s a natural way to increase loyalty, retention, and morale, as workers directly benefit from the company’s success.

Read on to learn more about what profit sharing is and how it can benefit you and your employees.

How Does Profit Sharing Work?

Profit-sharing is a compensation system where employees receive a percentage of their employer’s profits in addition to their regular pay and benefits, in order to help them pay for retirement. This can be offered as cash or stock options.

Unlike a 401(k), employees do not contribute to profit sharing, and it can be offered in addition or in lieu of a traditional 401(k).

Companies can choose what percentage of their profits go to a profit-sharing plan each year, though a company doesn’t have to be profitable to have one of these plans.

This means it’s a great option for employers who need flexibility and don’t want to contribute a mandatory fixed percentage to a 401(k) year after year. If you’re having a tough financial year, you don’t have to contribute to a profit-sharing plan at all. Your profit sharing formula can be set up as discretionary so you can use it when you want to.

Types Of Profit Sharing

If you’re interested in a profit-sharing plan for your business, there are a few different options. The three most common types of profit-sharing are:

  • Pro-rata plan – this is a plan where every employee receives the same rate of employer contributions. This rate is usually based on their salary.

  • Age-weighted plan – this type of plan has contributions that are based on their age, so it tends to favor older employees.

  • New comparability plan – this type of plan lets employers divide employees into groups and set different rates for different groups. These rates can be based on factors like how long the employee has been with the company, their age, or what department they work in.

Vesting Schedule

You have the option to put up to a six year graded vesting schedule on your profit sharing contributions to your employees. In a typical six year graded vesting schedule, an employee becomes vested in 20% of their accrued benefits once they have completed two years of service. Each year following the two years, they are vested another 20%. After six years of service they become fully vested. This is a great "golden handcuffs" type of benefit to offer your employees. If your employee terminates service before they are fully vested the portion of unvested money can go back into the plan and be used for your next employer contributions or it can be used to pay for plan administration expenses.

Profit-sharing can be used by businesses of any size, and are a great tool to keep employees motivated and invested in your success.

In fact, your plan most likely already has a profit-sharing option. However, it might not be the correct option for your company.

If you need help finding which profit sharing plan makes sense for your company, schedule a plan discussion with us or feel free to reach out to me directly.

Kurt S. Altrichter, CRPS®

Fiduciary Advisor | President

Direct: 952.828.5336


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