When reviewing an employee benefits package, you may come across profit-sharing 401(k)s. Profit-sharing plans are not as common as traditional 401(k)s, which is why many people are unfamiliar with them.
So what are they and are they good investments? In short, profit-sharing plans offer unique advantages for both employees and employers, yes. However, that doesn’t mean you should automatically accept or offer (if you’re a business owner) a profit-sharing 401(k) option instead of a traditional 401(k).
By the end of this article, you’ll understand profit-sharing 401(k)s and how they have the potential to be a great investment, whether you’re a business owner or an employee looking to gauge whether or not the benefits package you’re being offered is a good deal for you.
Before learning about profit-sharing 401(k)s, check out our managed IRA plans.
Instead of relying on some faceless person or bank to manage your retirement account and wealth, our experienced in-house investment professional will not only offer you investment recommendations, but also provide you with access to high-quality investment education via exclusive, interactive videos and other financial education content.
What Is a Profit Sharing 401(k)?
A profit-sharing plan is a type of 401(k) plan that allows employees to share in a company’s profits. The main difference between profit-sharing 401(k)s and other types of retirement plans is that a profit-sharing plan doesn’t rely on employee contributions. Instead, they are funded by the employer, regardless of whether or not an employee has contributed to the plan.
All in all, a profit-sharing 401(k) is a type of retirement plan that's designed to give employees who work for the company an opportunity to profit from their own hard work. This type of plan is becoming increasingly popular among companies. Why? It can create a sense of loyalty between employers and employees, which may lead to more productivity in the workplace. And, with the employment landscape changing rapidly post-pandemic, we know that these types of incentives are more important than ever.
Business owners, we’re talking to you! Not only could this be a great retirement plan option, but you may be eligible for tax incentives if you implement a profit-sharing 401(k) plan (and other retirement plan options!).
Profit Sharing 401(k) vs. Other Retirement Plans
As mentioned above, a profit-sharing 401(k) is a type of retirement plan that's designed to give employees who work for the company an opportunity to profit from their own hard work. However, the amount you’re able to save for your own retirement depends heavily on the results of the business as a whole and not just your own hard work.
So, are the retirement accounts good? They can be, sure, but what you’re really looking for is a managed IRA plan that is being personally managed by an expert investment professional. The Wealth Stack IRA Pack offers just that, along with:
- High-quality investment education for your employees
- Investment recommendations from a seasoned Wall Street professional
- FREE financial assessment and review of your business
Check out our managed IRA plans, which start out at just $49/month plus $7/employee.
Types of Profit Sharing Plans
There are two main types of profit-sharing plans to be aware of:
Stand-alone plan: With this type of profit-sharing 401(k), only employer contributions are allowed. In other words, employees are prohibited from making contributions to a stand-alone profit-sharing plan.
Combination plan: In contrast to a stand-alone plan, a combination plan allows employees and employers to contribute. This combines the advantages of a 401(k) and profit-sharing plan into one.
As an employee, you can imagine that the stand-alone plan benefits you quite a bit. However, with a combination plan you can also choose to make contributions if you want. This is extremely beneficial to you as well as it’s a great way to enjoy the tax-advantaged benefits of a retirement plan like a 401(k).
Is a Profit Sharing Plan the Same as a 401(k)?
Though profit-sharing plans and 401(k)s are both considered employer-sponsored retirement plans, there are some key differences. Namely…
- Profit-sharing plans are defined contribution plans. Unlike a defined benefit plan, this type of retirement plan does not provide you with guaranteed income in your later years. And, there's no guarantee that the company will put money into it each year, even if they're profitable!
- Contribution limits are different. With a 401(k) plan, you pay into the account as an employer, up to $19,500 per year if you’re under 50 and $26,000 if you’re over 50. However, with a profit-sharing plan, your employer can contribute up to the lesser of 25% of your salary or a maximum of $61,000 in 2022.
- With profit-sharing plans, you need to meet certain requirements to be eligible as an employee. This includes being at least 21 years-old and having worked for the company for at least a year or two. With a regular 401(k), you can contribute immediately (and even set up your own account if you’re a freelancer or business owner!).
Employees Share in Business Profits
Unlike traditional 401(k)s, a profit-sharing plan provides an opportunity for employees to participate in the financial growth of a business. Instead of receiving the same amount each year, like with traditional 401(k) plans, contributions to profit-sharing plans can vary based on the company’s performance.
Profit-sharing plans offer companies more flexibility than traditional 401(k)s regarding the plan’s design. With profit-sharing programs, employers have more discretion over contributions and can allocate a higher percentage of profits to certain employees. However, the allocation structure must be written into the plan document for transparency purposes.
Additionally, companies have more control over when they contribute to profit-sharing plans. Many employers choose to fund employee plans at the end of the year but can do so monthly or quarterly.
What Happens to My Profit-Sharing 401(k) Plan If I Quit My Job?
If you’re thinking about leaving your company, it’s a good idea to check on the rules regarding your profit-sharing plan. For example, whether you will be able to keep the money that has accrued in the plan. It will depend on whether you are fully “vested” or not.
Vesting refers to how much ownership you have over the assets in your retirement plan. For example, some companies won’t give you full rights to the money in your 401(k) until you’ve been at the company for a certain period of time (typically 1-3 years).
Every profit-sharing plan will have a different vesting schedule. This is why it’s essential to review your plan’s documents or contact your Human Resources department to find this information.
Which Retirement Plan is Best for You?
Profit-sharing plans can be beneficial to both employees and employers. Profit-sharing plans are a valuable tool to help you save for retirement. They can also help you benefit from a company’s growth–without investing your own money. What’s not to like?
However, when it comes to finding the right employment option for you, it’s best to speak with a professional. Why? There are a lot of factors that come into play. This includes your current income, your projected future income, your retirement goals, your age, and more.
If you’re a business owner and you’d like a free assessment of your retirement package options, schedule a free call with one of our retirement planning experts. Or, check out our plans here.
If you’re an employee looking to see which makes the most sense, we suggest downloading the Wealth Stack app to learn more about the differences between retirement accounts and how to invest in each one.
Download the Wealth Stack app for free on the App Store or on Google Play.