401(k) profit sharing plans: The nuts and bolts of a great benefit
Despite its name, profit sharing in a 401(k) plan doesn’t necessarily involve your company’s profits. So what is it? Profit sharing in a 401(k) plan is a tax deductible contribution employers may make to their employees’ retirement accounts after the end of the year.
The contributions are tax-deductible for the tax year the contributions are made for. The contributions must be deposited no later than the employer's tax filing due date plus extensions for the applicable tax year. This delayed approach provides employers the opportunity to assess their finances before deciding whether or how much they want to contribute to each eligible employee’s account.
Why businesses like profit sharing
Here are five potential benefits to offering a profit sharing plan:
1. It’s a bonus with tax benefits
One way to use profit sharing is to include it as part (or all) of your employees’ year-end bonus. These bonuses can boost your employees’ retirement savings without increasing their taxable income in a given year. Profit sharing contributions are also tax-deductible to the employer and aren’t subject to Social Security or Medicare withholding. As a year-end bonus, a profit sharing contribution may eventually be worth more to employees than a similarly-sized direct bonus payment.
2. The flexibility to plan your finances
Not sure if you can offer a potentially costly employee benefit every year? A profit sharing feature can be discretionary, which lets you decide after the end of the year if a contribution will be made. Contributions must be made before the tax filing deadline (including extensions), to be deductible on the previous year’s tax return. In February 2025, for example, your company can make a profit sharing contribution and deduct it on its 2024 tax return.1
3. Take care of Highly Compensated Employees (HCEs)
A profit sharing plan may allow you to make greater contributions to HCEs without failing IRS compliance limits for nondiscrimination testing.2 In addition, profit sharing contributions are not counted toward the employee’s IRS annual deferral limit.
4. A reward that can vest over time
Employers have the option to apply a vesting schedule to the profit sharing feature, rewarding employees for each year of service until they accrue 100% vesting in the profit sharing contributions. If employees leave the company before their contributions are fully vested, they forfeit the unvested portion. Vesting can incentivize retention, as employees retain a greater percentage of their employer contributions the longer they stay.
5. No extra work if you already offer a 401(k) plan
Most retirement plan providers offer plans that include a profit sharing feature. That means only one fee and one benefit to manage if you set it up right.
Popular formulas for profit sharing contributions
Along with making the decision to offer a contribution after the year is over, you will also need to determine how to allocate the contribution pool between your employees. To treat all your employees fairly (and stay compliant with the IRS), Guideline offers two design-based Safe Harbor formulas you can use to allocate profit sharing contributions, as well as one non-design-based Safe Harbor formula.
When you decide to make a contribution to your profit sharing plan, you do so by setting aside a “pool” of money that will be contributed across all your eligible employees. Let’s say you decide to contribute a total of $10,000. Here are examples of how they work with the two design-based safe harbor formulas:
Flat dollar amount method
This approach (which is also sometimes referred to as ‘same dollar amount’) is the most simple because every employee receives the same contribution amount. You calculate each eligible employee’s contribution by dividing the profit pool by the number of employees who are eligible for your company's 401(k) plan.
Example: The company profit sharing pool is $10,000 and there are three eligible employees. Each employee would get $3,333, regardless of their salaries.
| Employee | Salary | How it's calculated | Contribution $ |
|---|---|---|---|
| Alice | $40,000 | ($10,000/3) to each employee | $3,333 (8.33%) |
| Bob | $60,000 | ($10,000/3) to each employee | $3,333 (5.33%) |
| Carrie | $100,000 | ($10,000/3) to each employee | $3,333 (3.33%) |
The pro-rata method
Also known as the “comp-to-comp method,” this approach allocates the profit share based on employees’ relative salaries.
Example: The company profit sharing pool is $10,000, and the combined compensation of your three eligible employees is $200,000. As a result, each employee would receive a contribution equal to 5% of the employee’s salary.
| Employee | Salary | How it's calculated | Contribution $ |
|---|---|---|---|
| Alice | $40,000 | $40,000 * ($10,000/$200,000) | $2,000 (5.0%) |
| Bob | $60,000 | $60,000 * ($10,000/$200,000) | $3,000 (5.0%) |
| Carrie | $100,000 | $100,000 * ($10,000/$200,000) | $5,000 (5.0%) |
New comparability
A new comparability profit sharing formula may allow a greater disparity of contributions between different groups of employees. In other words, older employees with higher salaries can receive larger contributions than younger employees with lower salaries. A new comparability profit sharing formula is not a design-based safe harbor so must pass IRS testing to prove nondiscrimination. Using a new comparability profit sharing formula is generally desirable for business owners and executives who are older, make more money than other employees, and want to maximize employer contributions to their own accounts. The new comparability profit sharing formula is available in Guideline’s Enterprise tier, but may incur a fee for plans on the Guideline Core tier in each year it is used.3
The first step in making a new comparability profit sharing contribution is to allocate a "minimum gateway" contribution to all Non-Highly Compensated Employees (NHCEs), usually between 3% and 5% of compensation. It’s generally recommended this minimum contribution be fully or partially made in the form of a Safe Harbor nonelective contribution to automatically pass nondiscrimination testing.
The next step is to calculate the contributions to be made to each employee in such a way that the value of the future retirement benefit derived upon attaining normal retirement age is the same for all eligible employees.
Example: The owner of a small business is a 50 year old with a high income. Using a new comparability profit sharing formula, the owner is able to receive a larger profit sharing contribution than the younger and lower income employees.
| Participant | Age | Salary | Contribution % | Profit Sharing $ |
|---|---|---|---|---|
| Owner | 50 | $200,000 | 10.0% | $20,000 |
| Alice | 25 | $40,000 | 3.33% | $1,340 |
| Bob | 30 | $60,000 | 3.33% | $2,000 |
| Carrie | 35 | $80,000 | 3.33% | $2,670 |
New comparability profit sharing may be appropriate for a small business if:
- You'd like to maximize employer contributions made to owners
- Owners are generally older than non-owner employees
- Owners receive higher compensation than non-owners
- You have a small number of employees (usually fewer than 50)
Because new comparability profit sharing calculations are based off year-end employee census and compensation information, changes in personnel can significantly impact projected contributions. As such, specific results can’t be guaranteed until year-end data becomes available.
These examples are illustrative and should not be considered tax, legal, or investment advice.
Limitations to profit sharing plans
There are a few limitations to remember when making employer contributions, such as profit sharing:
- Employers can only deduct contributions to retirement plans of up to 25% of total eligible employee compensation.
- Total contributions for each employee (including employer contributions and employee deferrals) may not exceed 100% of the employee’s compensation for the applicable year.
- Total contributions to an employee are also limited to $70,000 for 2025 (or $77,500 if an employee is over age 50).4
- For 2025, annual compensation used for employer contributions is limited to $350,000 can be used for the calculation of any employer contribution.4
Making an annual profit sharing contribution is a great way to thank your employees for their work while being mindful of your finances. Use the checklist below to see if a Guideline plan is right for you.
The 401(k) checklist
| Questions you should ask | Guideline | Other provider |
|---|---|---|
| Plan design and setup | ||
| Do you provide the 401(k) plan document? | ✅ No extra fee3 | |
| Can you set up a safe harbor 401(k)? | ✅ No extra fee3 | |
| Can you set up a QACA safe harbor 401(k)? | ✅ No extra fee3 | |
| Do you support legally related groups? | ✅ Starter and Enterprise tier only | |
| Do you support automatic enrollment? | ✅ No extra fee3 | |
| Do you allow profit sharing? | ✅ Core and Enterprise tier only | |
| Do you offer a personalized onboarding specialist and account manager? | ✅ Enterprise tier only | |
| Employee education and recordkeeping | ||
| Do you handle employee notices and employee education? | ✅ No extra fee3 | |
| Do you offer live support via phone and email? | ✅ No extra fee3 | |
| Can employees access their account via mobile app? | ✅ No extra fee3 | |
| Administration and recordkeeping | ||
| Are you a 3(16) plan administration fiduciary? | ✅ No extra fee (available to clients who use an eligible payroll provider)3 | |
| Do you integrate with certain payroll software? | ✅ No extra fee3 | |
| Do you track employee eligibility? | ✅ No extra fee3 | |
| Do you review and approve hardship withdrawals, loans, and QDROs? | ✅ No extra fee3 | |
| Compliance and reporting | ||
| Do you monitor the 401(k) plan for compliance? | ✅ No extra fee3 | |
| Do you prepare and file the Form 5500 Annual Report? | ✅ No extra fee3 | |
| Investment management | ||
| Are you a 3(38) investment management fiduciary? | ✅ No extra fee3 | |
| What investments are available? | 40 funds across diverse asset classes | |
| Do you offer any managed investment options? | 6 managed portfolios | |
| Do you offer custom portfolio design? | ✅ No extra fee3 | |
| Do you offer automatic rebalancing? | ✅ No extra fee3 | |
| Pricing and fees | ||
| What recurring fees are paid by the employer? | Three great plans that start at $39/month plus $4/participating employee3 | |
| Are there any additional setup, rollover, or transaction fees? | No | |
| Are there any fees for filing the Form 5500 or Form 8955-SA? | No | |
| What asset based fees do employees have to pay? | Participating employees pay an annual account fee to Guideline, starting at .15%5 | |
| What fees are associated with the investments themselves? | The estimated total AUM fees for the managed portfolios can be under 0.22%6 |