401(k) Profit Sharing
A Profit Sharing Plan is a defined contribution plan in which the employer makes discretionary contributions. A key advantage is flexibility in determining the annual contribution.
The maximum annual employer deduction for contributions is 25% of eligible compensation. There is also a maximum individual contribution limit. The individual limits are adjusted annually for cost-of-living increases.
Key Features
- Tax-deferred investment
- Flexibility in plan design
- Contributions discretionary
- Contributions may be deductible by employer
How it Works
In a cross-tested formula, employees are assigned to classification groups based upon ownership or job title. Each group receives a different percentage of the contribution, subject to nondiscrimination testing. The advantages are:
- Allocation percentages favor the owner
- Discretionary, tax-deductible contributions
- Availability of life insurance with tax-deductible premiums
Profit Sharing Formula Comparison
Salary Proportion and Cross-Tested
Scenario: Business owner age 55, spouse 52; two employees age 24 and 33
| Salary Proportion Formula | Cross-Tested Formula | |
| Owner & Spouse | $67,000 | $94,000 |
| Employees | $10,400 | $2,600 |
| Total | $77,400 | $96,600 |
| % to Owner & Spouse | 87% | 97% |
Contributions are for illustration purposes only, and actual contributions may vary. Contributions are calculated based upon individual census data. Values as of 01/01/2019