For quite some time, profit-sharing plans have been recognized by many small business owners and professionals as effective, qualified retirement saving tools. Generally, these plans allow employees to share company profits, as employers make contributions to participant accounts based on each participant’s annual compensation. However, if you are an older business owner, you may want a plan that provides you with the opportunity to maximize your contributions.
One strategy you may want to consider is an age-weighted profit-sharing plan. With this type of plan, it is possible to base contributions on a participant’s age, as well as salary, benefiting older participants without running afoul of Internal Revenue Service (IRS) nondiscrimination requirements.
The uniform points allocation formula is typically used to determine benefits for an age-weighted plan. This formula assigns a predetermined number of points for each year of age, and some plans also set a maximum age limit. For example, if the formula allows for 10 points per year, an employee who is age 25 receives 250 points, whereas an employee who is age 55 receives 550 points. The allocation to each participant’s account is determined by multiplying the employer’s contribution by a fraction; the numerator is the total of points assigned to the participant, and the denominator is the total assigned to all participants.
The formula determines not only an allocation of contributions, but also an allocation rate, used for nondiscrimination purposes, which is a percentage that represents an employee’s yearly compensation divided by his or her contribution allocation. In order for a plan to be nondiscriminatory, the average allocation rate of highly-compensated employees may not be greater than the average allocation rate of employees who earn less.
Age-weighted profit-sharing plans are some of the most flexible types of qualified plans available, and they can be ideal for small business owners seeking to maximize their own contributions. However, as with all planning matters, every situation is different and has its own variables and circumstances. Be sure to consult your qualified tax and legal professionals to determine the type of plan that best meets your needs.