Profit sharing plans offer both design flexibility and discretion as to making contributions. Company contributions are determined by the employer and can be allocated in a number of ways. If the company makes little or no profit during a year, no contribution is required, although low profits don't restrict the contribution level. A profit sharing plan can include an option allowing the company to make contributions even if the company has no profit.

Eligibility

Typically, the eligibility provisions require an employee to have one year of service and be at least 21 years of age. A two-year service period may be imposed if full immediate vesting is provided. For most plans, a year of service is defined as working 1,000 hours in a plan year.

Contributions

An employer's maximum deduction is limited to 25% of the annual compensation paid to eligible employees. The individual maximum contribution limits for employees applied to all defined contribution plans are the lesser of 100% of compensation or $40,000. Depending on the allocation formula in a profit sharing plan, the contributions for individual employees may exceed the 25% level as long as the aggregated employer contribution does not exceed the 25% maximum employer contribution limit.

Advantages

The employer can make a discretionary contribution each year, which can be subject to a vesting schedule. A profit sharing plan may be integrated with Social Security or may utilize one of the allocation methods described in a later section.

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