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Profit Sharing Allocations Explained

Most profit sharing/401(k) plan sponsors have a basic understanding of how profit sharing works: that under the tax code, their contributions to the plan must not discriminate in favor of the owners and other highly paid participants. Many business owners interpret this to mean, “I can’t contribute more for myself than I do for my employees,” a white paper from the Manning Napier investment management firm notes.

In a general sense, that’s true. But in a more specific sense, there is flexibility in the way a profit sharing contribution can be allocated to different groups or classifications of employees. Certain methods will better enable the business owner to control the cost of allocations to non-owners, while preserving desired allocations for owners and other executives, the white paper notes.

The paper explains the various allocation methods the tax code allows in the context of which method is the best choice depending on the plan sponsor’s intent:

• Employers desiring to treat all participants equally from an allocations perspective, and only wishing to control cost by the amount of the overall contribution, will benefit most by the Salary Ratio and Integration methods.
• Employers seeking to make age the chief driver in the overall allocation percentage will benefit from the Age-Weighted approach.
• Employers seeking the maximum flexibility in minimizing cost on certain participant classifications while maximizing allocations to certain key owners and executives will benefit the most by the New Comparability allocation method.

The paper is a good primer for your compliance and plan design toolbox, and a useful resource you can share with clients.
https://www.manning-napier.com/Portals/0/documents/insights/white-papers...

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