Pros And Cons Of Profit Sharing 401K Plan Features

If you want to design a 401k for your company, you likely have come across something called a profit-sharing plan. Profit-sharing is one of many features you can design in your company's 401k.  However, profit-sharing has certain benefits and drawbacks to consider. Keep reading to learn more about the pros and cons of 401k profit sharing.

What Are Profit-Sharing Plans?

Profit-sharing plans give employees a certain percentage of profits as part of their retirement package. Usually, the company bases the compensation on quarterly profits. Therefore, these plans can give all your employees an invested interest in how well the company performs. Profit-sharing plans offer employers more flexibility than traditional 401k plans with fixed contribution amounts.

You can modify these plans in many ways. For example, you can design a plan that rewards people who have been there longer. However, you must design a nondiscriminatory plan. Nondiscriminatory means you cannot have a plan that favors higher compensated employees over others.

What Are the Pros and Cons of Profit-Sharing Plans?

Profit-sharing plans can be beneficial or a hassle depending on your company. Here are some pros and cons of them.

Pros

• Your employee compensation is based on your profits. If you run a new company and don't make much, you won't need to pay out as much.
• You won't have the burden of paying a fixed compensation rate during unprofitable times.
• Your employees don't need to make any contributions of their own.
• You can take care of employees who can't afford to save for themselves. Some employees are unable to voluntarily contribute to their retirement.
• You can create a vesting schedule that incentivizes employee retention. For example, you can require that employees work a certain number of years before they are guaranteed the money in the plan.

Cons

• The IRS has strict rules about nondiscrimination. You must design a plan with consistent rules for all employees.
• Many companies won't or cannot pass the nondiscrimination tests.
• Employees cannot voluntarily contribute to a profit-sharing plan. However, you can have profit-sharing and a traditional 401K plan together.
• The plan is more complicated and requires more administration than other features and plans.
• Employees may expect compensation even when you don't have any profits.

These are just the basic pros and cons of a profit-sharing 401k. Designing a 401k plan can be complicated. Because of all the intricate tax rules, you could spend a lot of time going over the rules and administrating the plan. Therefore, hire someone well-versed in 401k plan design and profit-sharing. Contact a financial company that specializes in this task to get started.