Before choosing a profit-sharing plan or a 401(k), it’s important to understand what they are.
All retirement plans are profit sharing plans. A profit-sharing plan is one where the employees don’t make contribution and the employer has the option to make contributions on behalf of the employees.
A 401(k) plan is a profit-sharing plan with an additional feature where employees make contributions on a pre-tax basis from their earnings. An employer has the option to match contributions.
A Roth 401(k) is like a 401(k) except that contributions are made on an after-tax basis and grow tax-free.
While most of our competitors only offer their clients a 401(k), Benetrends offers all types of retirement plans. Because of our experience and expertise, we can offer the plan that makes the most sense depending on the needs of the business and the employer/employees.
However, in our three decades of experience, a profit-sharing plan is most used by newly established businesses.
Let’s look some reasons why this is the case:
1. A 401(k) plan requires additional ongoing administration with rigid compliance requirements.
Example A: If an employer doesn’t make the 401(k) feature available to an employee upon becoming eligible, the employer must make a contribution for the missed employee, even though the employee was paid the salary.
Example B: If 401(k) contributions are not deposited into the plan within seven business days of a pay date, there is a 15% excise tax on the lost earnings. The employee must be made whole for the lost earnings.
This eligibility tracking and the burden of making timely deposits into the plan account creates an unnecessary distraction to running your business.
2. If the employer is a highly compensated individual and his or her employees don’t make contributions to the 401(k), then he or she cannot contribute to the plan unless he or she makes a 3% contribution for all the employees.
3. Unlike our PSP, all employee contributions to a 401(k) are subject to FICA and Medicare taxes. If an owner is making employee contributions (and is earning below the social security wage base), they will be required to pay both sides of the tax totaling 15.3%.
Example A: If you are using one of our competitors 401(k) plans and you make a $15,000 contribution to your 401(k), you will be required to pay $2,295 in FICA and Medicare taxes. This in combination with paying the employer FICA on any employee contributions makes our competitors plans very expensive.
With our PSP, you are not required to pay FICA on your contributions, therefore making this option much less expensive for a new business.
If you are going to use retirement funds for your business funding, you will need to establish a retirement plan. To learn more about 401(k) rollover funding, download our eBook The Definitive Guide To ROBS/401(k)Business Funding: Launching A Business with Retirement Funds.