1. Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company1 A profit sharing plan is a defined contribution plan featuring a flexible employer contribution provision –Contribution can be a purely discretionary amount or based on some type of formula –Employer contributions allocated to individual accounts of participants on nondiscriminatory basis –Plan benefits consist of the amount accumulated in each participant’s account at retirement or termination –Plan benefits usually distributed in a lump sum at termination What is it?

2. Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company2 When employer’s profits varies from year to year When employer wants an incentive feature When employee group is –Relatively young –Willing to accept a degree of investment risk When employer wants to supplement an existing defined benefit plan When is its use indicated?

3. Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company3 Maximum contribution flexibility for employer Contributions can be made even if no profits Provides a tax-deferred retirement savings medium for employees Participants can benefit from good investment results Advantages

4. Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company4 Retirement benefits may be inadequate for employees entering the plan at later ages Relative amount of plan funding available for highly compensated employees is more limited Employees bear investment risk under the plan Level of employer funding less predictable Disadvantages

5. Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company5 Discretionary contribution provision –Employer can determine amount each year –Employer can omit contribution in a given year –But, IRS regulations require contributions to be “substantial and recurring” Formula provision –Specified amount contributed each year –“Profits” may be defined as specified by employer –Possibly can include a “fail-safe” provision Design Features

6. Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company6 All plans must have formula for allocating employer contributions to participant accounts –Cannot discriminate in favor of highly compensated employees –“Compensation” must be defined in nondiscriminatory way –Amount of compensation taken into account is limited –Can be based on compensation or years of service, integrated with Social Security Design Features

7. Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company7 Vesting provisions –Any vesting provision permitted by Code can be used in general –Special vesting requirements for “matching contributions” –Forfeitures (non-vested amounts “forfeited” upon leaving early) usually added to remaining participants’ accounts –Formula for allocating forfeitures usually same as that used for allocating employer contributions Design Features

8. Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company8 Distribution provisions –Benefits usually payable at termination of employment or at plan’s stated “normal retirement date” –Payable in a lump sum or a series of installment payments –Generally allow “in-service” distributions (benefits payable before termination of service) –Funds available for “in-service” distributions must be vested and must have been in the plan at least 2 years –10% early distribution penalty may apply to distributions prior to age 59-1/2 Design Features

9. Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company9 Employer contributions deductible when made Maximum deductible employer contribution may not exceed 25% of the payroll of all employees covered under the plan IRC Section 415 limits the “annual additions” (employer contributions, forfeitures form other participant’s accounts, and employee contributions) Tax Implications

10. Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company10 Taxation of employees deferred until amounts withdrawn Lump sum distributions may be eligible for 10-year averaging for employees born before 1936 Plan subject to ERISA reporting and disclosure rules Tax Implications

11. Profit Sharing Plans Chapter 17 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company11 Money purchase pension plans (no employer contribution flexibility) Cross-tested, age-weighted and target plans (more favorable for older employees; discussed later) Defined benefit plans (provide more security; more complex and costly) Nonqualified deferred compensation plans Alternatives