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Profit-Sharing Plans
David Wray, the president of the Profit Sharing/401(k)
Council of America, once said that the purpose of profit-sharing plans is
“to generate goodwill and a feeling of partnership” between employer and
employee. Profit-sharing plans give employees a share in the profits of a
company each year and can help to fund their retirements.
All funds contributed to a profit-sharing plan accumulate tax
deferred, as with other defined-contribution retirement plans, but employer
contributions are tax deductible only if the plan is defined as an
elective deferral plan, which means that instead of accepting their
profit shares as cash, employees defer the assets into retirement funds.
Profit sharing is attractive to business owners because of
its flexibility. Employers can choose how much to allot to employees each
year based on the amount of revenue taken in. There is no required minimum.
If the company has a bad year, the employer has the option of giving very
little or nothing at all to employee accounts.
Employees are usually enrolled automatically in profit
sharing once they become eligible. Companies can choose eligibility
requirements based on age and length of service. In 2007, a company is
allowed to contribute up to 25% of an employee’s salary or $45,000
(whichever is less). This amount is indexed annually for inflation.
Typically, companies set up vesting schedules that dictate
how long workers must be employed in order to claim profit-sharing
contributions when they move to another job or retire. Once employees are
fully vested, they can take the entire amount contributed on their behalf
and roll it over to an IRA or to a new employer’s qualified retirement plan.
If you participate in a profit-sharing plan, you may begin
withdrawing funds after age 59½ without incurring a 10% income tax penalty.
Withdrawals are taxed as ordinary income. Some plans may allow early
withdrawals. Profit-sharing providers have greater flexibility when it comes
to deciding the terms of early withdrawal than do administrators of other
plans, such as 401(k)s. However, the trend has been to permit no early
withdrawals.
As with other retirement plans, you must begin taking
required minimum distributions after reaching age 70½. You can elect to
withdraw the assets as a lump sum and be taxed on the entire value of the
fund or you can set up a minimum distribution schedule based on your life
expectancy.
Some companies offer a combination arrangement with both a
profit-sharing plan and a 401(k). A conjoined plan allows employers to
contribute as much or as little as they would like each year, while giving
employees a way to supplement their retirement funds.
If you are a business owner, profit sharing may be a way to
attract high-caliber employees. It provides retirement funds for your
employees, yet allows you the freedom to choose how much you wish to
contribute each year.
© 2007 Emerald Publications
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