If you run a small company or professional practice
and you're considerably older than your employees,
an age-weighted profit-sharing plan may be appealing.
Most of the contributions can go into your own retirement
account and the accounts of co-owners who are starting
to show a few gray hairs.
Generic profit-sharing plans
In a standard profit-sharing plan, the company will
contribute a certain percentage of pay to participating
employees' accounts within the plan. That percentage
can vary each year, from 0%-25% of pay, regardless
of the company's profitability. Each employee gets
the same percentage of pay. Contributions are tax
deductible for the company.
Example #1: Connie Simmons is the sole owner
of DEF Co., earning $100,000 a year. She decides to
make 25% profit-sharing contributions for all employees.
Thus, Connie's account gets $25,000, while a salesman
earning $60,000 gets a $15,000 contribution, and a
secretary earning $40,000 gets a $10,000 contribution.
The maximum contribution for 2008 is $46,000, per
the IRS. If a profit-sharing plan also includes a
401(k), participants 50 and older will be able to
make a $5,000 catch-up contribution in 2008, bringing
their maximum to $51,000.
Cost control
From a business owner's perspective, a standard profit-sharing
plan may be expensive. To bring the owner's contribution
up to the $46,000 maximum, the company might have
to contribute 20%-25% of pay for each employee. To
cut costs while maximizing your personal contribution,
consider an age-weighted profit-sharing plan. The
older you are, compared with the company's other workers,
the more you can tilt such a plan in your favor.
Depending on the makeup of the company workforce,
a 50-year-old business owner might get 20% of pay
contributed to his account while a 25-year-old assistant
gets only 3% of pay. The IRS may allow this difference
because the assistant's contribution has 25 more years
to grow, untaxed. Thus, the disparate contributions
might be deemed appropriate.
The weighting game
In a simple scenario, an age-weighted plan may work
well for business owners. That's not always true,
however.
Example #2: GHI Co. has four owners, ranging
in age from the upper 30s to the low 50s. With a straight
age-weighted plan, a larger contribution will go to
the oldest owner, which might displease the youngest
one. An age-weighted plan also may prove to be impractical
if a lower-wage employee is older than the business
owners. That employee might be entitled to a large
profit-sharing contribution, as a percentage of pay.
In such situations, a specific type of age-weighted
plan might be more appealing. In a "new comparability"
or "cross-tested" plan, the age weighting
is done by groups of employees, not by individuals.
Profit-sharing contributions are determined by the
average age within the group. Thus, if the average
age of the owner group (which might consist of only
one person) is greater than the average age of other
employees, contributions can be tilted toward the
owners. Often, 90% or more of the company's contributions
can go to the owners and other key employees, who
receive maximum or near-maximum contributions while
relatively little goes to the rank-and-file.
Proceed with caution
Age-weighted profit-sharing plans - especially new
comparability plans - can require steep setup and
administrative costs. IRS rules in this area can be
complex. Our office can help you put together a plan
that will stand up to scrutiny. You also should be
aware that such plans can be detrimental to morale
if young workers feel their retirement plan contributions
are too low. Nevertheless, if amassing a large retirement
fund for your own use is a key goal, an age-weighted
profit-sharing plan may suit your purposes.
