Profit sharing plans can be a powerful tool in promoting financial security in retirement for many reasons including one of the most important: a well-designed profit sharing plan can help attract and retain talented employees to drive revenue.
Many small businesses choose profit sharing plans – also called a defined contribution plan — because of the great flexibility inherent in these plans. Contributions are strictly discretionary; in months when cash flow is good, you may contribute more, and in tighter months, you may contribute less if at all.
In every profit sharing plan, the money contributed may grow through investments. No Federal or State taxes are levied on gains until distributions – or withdrawals – are taken upon retirement.
The most important step in implementing a successful profit sharing plan is to have a very focused vision of what you want to achieve through the initiative. Traditional profit sharing plans are used as a retirement benefit. You contribute a specific, predetermined amount of your annual profits into a deferred trust, which employees can access upon retirement. The maximum contribution is $53,000 for 2016, or 25 percent of an employee’s compensation and an annual filing of the IRS 5500 Form is required.
But if the goal is to motivate employees, a cash profit sharing plan – which is not a retirement plan – may be a better option. In this profit sharing plan, a predetermined share of your profits is paid directly in cash or stock, and bonuses are taxed as part of the employee’s overall wages (unlike a deferred plan). Through this plan, you have more flexibility to establish the rules and to determine who’s eligible and how much they are paid out of profits.
As with 401(k) plans, you can make a profit-sharing plan as simple or as complex as you wish. The amount allocated to each individual account is usually based on the salary level of the participant-employee. It’s typical for small businesses to determine that 10 to 15 percent of their pre-tax profits will be eligible for distribution.
You need to take a good, close look at your balance sheet and income and perhaps set a specific revenue target to meet before you make your profit sharing contribution at regular intervals. Eligibility is another criteria; some profit sharing plans are only targeted towards the management partners (although a deferred plan requires that everyone participate).
Profit sharing plans are good choices if your business or practice experiences fluctuating earnings and you need the flexibility to vary contributions or if your business or practice is growing at a rapid pace. The benefits are attractive: tax deductibility for you, tax deferral for your employees.
Since investment options – and choices of formula to determine contributions – are numerous, it pays to work with a financial planning firm. BeamaLife knows the ins and outs of profit sharing plans and can help you decide what type of plan is best for your business or practice. Let’s discuss the profit sharing plan that’s right for you.