Combining Qualified Profit-Sharing Plans with 401(k) Plans: Is It Possible?

Thank you for joining us for the fifth article in our profit-sharing series. Last time, we talked about Employee Stock Ownership Plans (ESOPs). You learned about the origins of these equity-based profit-sharing schemes, how they are designed, and the unique tax advantages for business owners, managers, and employees.

In today's piece, you'll understand retirement plan integration with qualified profit-sharing plans. By reading, you’ll gain insights into how entrepreneurs can combine 401(k) plans with qualified profit-sharing plans. Join us below.

Can Business Owners Combine Profit Sharing with 401(K) Plans?

Simply put, yes, business owners can combine qualified profit-sharing programs with 401(k) plans. Such arrangements are profit-sharing 401(k) plans or 401(k) plans with a profit-sharing component.

At its core, such a program functions as a standard 401(k) plan where workers contribute a portion of their salary to their retirement savings account. These contributions grow tax-deferred until retirement, when the individual is likely to be in a lower tax bracket.

Now, enter the profit-sharing element. Under a combined arrangement, the employer contributes a portion of company profits to employee 401(k) accounts. This retirement savings strategy offers the tax advantages of a 401(k) and aligns employee interests with the company's success.

Benefits of Combining Profit Sharing and 401(k) Plans

Here are the benefits of this retirement savings strategy for Business owners and their employees:

For Employers

• Flexibility in Contribution: One of the primary advantages of combining 401(k) plans with qualified profit-sharing plans is the employer contribution can be adjusted based on the company’s performance.
• Attract and Retain Top Talent: Profit-sharing 401(k) plans can attract and retain key talent since they offer a dual incentive: financial planning for retirement and a share in the company's success.
• Employer contributions are tax-deductible:- Any 401(k) plan contributions are tax-deductible, providing an immediate tax advantage for employers.
• Enhances employee retention: Employers can set vesting schedules on their contributions to the plan, ensuring that staff stay with the company for a certain number of years before they are fully vested in the contributions.

Employee Benefits

Here’s how workers benefit from 401(k) plans with a profit-sharing component:

• Retirement savings strategy: Profit-sharing 401(k) arrangements offer a solid retirement savings plan with the advantages of a standard 401(k) and company contributions adding to their retirement investment.

• Tax advantages: Employee 401(k) contributions grow tax-deferred until retirement. This means workers only pay taxes on the funds directed to the account once they gain full access to the investment, usually at retirement.

• Share in company success: Profit-sharing plans allow company staff to share in the company's profits, which boosts morale and aligns their long-term interests with the company's goals.

Key Considerations for Businesses

At this point, you know the benefits of profit-sharing 401(k) plans for business owners and their staff. Here are a few factors to keep in mind as you implement these strategies:

• Profit Allocation Formula: You'll need to select a profit allocation formula according to your workforce demographics and company goals. For more information on how the profit allocation formula works, refer to our previous publication on that topic.

• Compliance with ERISA regulations: As you design and implement the plan, you must comply with ERISA's participation and nondiscrimination guidelines. That's why we encourage you to work with a qualified business attorney. They will offer counsel to help you implement a plan that complies with ERISA guidelines.

Conclusion

As you can see, integrating a qualified profit-sharing plan with a 401(k) plan can enhance employees' investment savings potential while aligning their interests with the company's success. Join us next week for another enlightening piece on non-discrimination rules for qualified profit-sharing plans. See you then!

Are you wondering about any of the issues mentioned above? Please email us at info@wilkinsonlawllc.com or call (732) 410-7595 for assistance.

At Wilkinson Law, we give business owners the clarity they need to fund, grow, protect, and sell their businesses. We are trustworthy business advisors keeping your business on TRACK: Trustworthy. Reliable. Available. Caring. Knowledgeable.®