Businesses typically choose to help their employees' retirement savings via:
1. steadfast matching contributions to a 401(k) plan, or
2. variable contributions in a profit-sharing plan
The choice is dependent on what makes the most sense for their business.
But can a company choose to do both a 401(k) with matching and a profit-sharing plan?
The Benefits of Matching and Profit-Sharing
Short answer: yes, a company can choose to match its employees’ 401(k) contributions and add additional profit-sharing within the 401(k) plan. Why might an employer choose this route?
First, it ostensibly motivates employee performance. Harder work leads to more profit. More profit leads to more profit-sharing. And that added compensation leads to more satisfied employees.
Second, if the company has underperformed in the previous fiscal year, they could limit extra compensation to their employees. Profit-sharing is an excellent option for this situation.
But since this is all occurring within a 401(k) plan, the employees can make their retirement contributions, and the employer can match contributions.
Why Not Both?
Why not enact both a matching 401(k) and a profit-sharing plan at your company? Great question!
Nothing is standing in your way from enacting both plans. Sure, it does require a bit more work from all parties involved. There is extra paperwork for administrators, extra understanding needed on the part of employees, and extra calculations needed from accounting and payroll.
But the benefit of this two-pronged approach is that it provides an entire host of benefits to the employees.
The employees can choose to contribute to their 401(k). And depending on fiscal performance, the company can decide how it matches those funds. Simultaneously, the company can attempt to motivate employee performance via the variable profit-sharing plan.
And there is a big potential for motivation! Profit-sharing is capped at the lesser of $58,000 or 25% of the employee's salary. Even without a 401(k) match, a dual 401(k) plan + profit-sharing plan could see employees taking home $19,500 + $58,000 = $77,500 in retirement savings per year.
But keep this in mind: since this is all occurring within a 401(k), standard IRS non-discrimination rules apply. This plan cannot unfairly favor highly compensated employees.
That is why it makes sense to consider the profit-sharing calculations carefully. Three standard methods are the flat method, the comp-to-comp method, and the new comparability method.
The flat method of profit-sharing gives an equal profit share contribution to all employees. From the boss to the new associate, each employee gets an equal share of the profit-sharing pot.
The comp-to-comp method (a.k.a. the pro-rata method) doles out the profit-sharing in proportion to each employee's salary. If the boss's salary is twice as much as the new associate, the boss will receive twice as much profit-share as the new associate.
The new comparability method gives employers flexibility by judging each employee or group of employees separately. In short, the new comparability method recognizes that a dollar given to a young employee (decades from retirement) will grow more than a dollar given to an older employee (only years from retirement). Thus, the dollars given to the young employee have more value to them. As with the other methods discussed here, fair compensation audits from the IRS still apply.
Matching & Profit-Sharing Summary
You can do both matching and profit-sharing in your 401(k) plan. Should you? That is up to you, your financial team, and your employees’ wants and needs.