Profit-sharing contributions are employer-funded contributions made to employees’ 401(k) accounts. These contributions are optional and allocated annually during nondiscrimination testing to ensure they meet IRS nondiscrimination rules. Profit sharing is a non-elective employer contribution, made at the employer’s discretion and often based on company performance. Unlike a match, it doesn’t require employees to contribute their own money.
How is profit sharing different from an employer match?
• Employer match: tied to what employees contribute, with the employer matching a percentage of what they save.
• Profit sharing: independent of employee contributions and decided each year.
Can nonprofits make profit-sharing contributions?
Yes. Despite the name, profit sharing isn’t limited to for-profit companies. Nonprofits can make profit-sharing contributions based on financial performance or a set formula, rather than profits.
How Are Profit-Sharing Contributions Allocated?
The plan document specifies how profit-sharing contributions are distributed among employees. The chosen allocation method affects nondiscrimination testing and must be followed as outlined in the plan. Common profit-sharing methods include:
• Pro-Rata Allocation: Every eligible employee receives a contribution equal to a fixed percentage of their compensation, ensuring equal treatment across all participants. This is the most common profit sharing allocation. Pro-rata allocations automatically satisfy the relevant nondiscrimination test.
• New Comparability (Cross-Tested): Contributions vary between employee groups, allowing employers to provide higher contributions to certain groups (such as key employees or highly compensated employees(HCEs)). This method requires additional nondiscrimination testing for 401(k) plan compliance. This option is only available at Betterment to Pro and Flagship plans.
• Integrated (Permitted Disparity): Employees earning above the Social Security wage base receive higher contributions than those earning below it, aligning with IRS-permitted contribution differences. This option is only available at Betterment to Pro and Flagship plans.
Employers should review their plan document to confirm the correct allocation method and report the intended budget in the compliance questionnaire to ensure proper testing and funding.
How do I make a profit-sharing contribution?
Profit-sharing contributions are made once a year through your annual compliance testing, not through payroll. Here’s how it works:
1. Tell us in your compliance questionnaire. In January, go to Plan Sponsor Dashboard > 401(k) Plan > Compliance and complete your annual questionnaire. In the Discretionary employer contribution section, indicate that you’d like to make a profit-sharing contribution and enter the total amount. If your plan uses an allocation method that allows different amounts for different employee groups (New Comparability or Integrated, available on Pro and Flagship plans), you can also tell us how you’d like it divided.
2. Complete any extra steps your plan requires. If your plan uses New Comparability or Integrated, you may need to complete an additional questionnaire and work with our 401(k) Compliance team, since these methods have extra testing requirements.
3. We calculate each employee’s share. We review your plan and census information and work out an allocation that follows your plan’s rules and compliance limits.
4. Review and approve it. When the allocation is ready, it appears as a Year-End Action in your Plan Sponsor Dashboard. Once you review and approve it, we process the contribution.
Profit-sharing contributions are optional, so you can decide each year whether to make one, and the amount can change from year to year.
Key Deadlines and Compliance Considerations
• Profit-sharing contributions must be funded by the company’s tax filing deadline, including extensions, to qualify for a tax deduction in that year.
• Contributions must pass nondiscrimination testing to confirm they do not disproportionately benefit HCEs.
Accurately reporting and planning for profit-sharing contributions helps ensure compliance and maximizes the benefit for employees.