Profit Sharing Plan: Operating The Plan

Profit Sharing Plans

Operating The Plan

 
 

Once you have established a profit sharing plan, you assume certain responsibilities in operating it. If you hired someone to help in setting up your plan, that arrangement also may have included help in operating the plan. If not, another important decision will be whether to manage the plan yourself or to hire a professional or financial institution – such as a bank, mutual fund provider, or insurance company – to take care of some or most aspects of operating the plan. Elements of operating profit sharing plans include:

  • Participation
  • Contributions
  • Vesting
  • Nondiscrimination
  • Investing profit sharing plan monies
  • Fiduciary responsibilities
  • Disclosing plan information to participants
  • Reporting to government agencies
  • Distributing plan benefits


Participation

Typically, a plan includes all employees. However, a profit sharing plan may exclude some employees
if they:

  • Have not attained age 21;
  • Have not completed a year of service (2 years in certain plans);
  • Are covered by a collective bargaining agreement that does not provide for participation in the plan, if retirement benefits were the subject of good faith bargaining; or
  • Are certain nonresident aliens.

Employees cannot be excluded from a plan merely because they are older workers.


Contributions

In a profit sharing plan, you can decide on your business’s contribution to participants’ accounts in the
plan. You have the flexibility of changing the amount of contributions each year, according to business conditions.

The plan document will need to have a set formula to determine how any contributions you make are allocated to participants’ accounts. The simplest, and most common, allocation formula specifies that the employer contribution is allocated so that each participant receives an amount that is the same percentage of his or her compensation.


Contribution Limits

Contributions and forfeitures (nonvested employer contributions of terminated participants) are subject
to a per-participant annual limitation. This limit is the lesser of:

  • 100 percent of the participant’s compensation, or
  • $53,000 for 2016 and $54,000 for 2017.

If contributions are made to a profit sharing plan, employers can deduct amounts not exceeding 25
percent of the compensation paid during the year to all participants.


Vesting

Your contributions to the plan can either be fully vested (nonforfeitable) when made or they can vest
over time according to a vesting schedule.

If you require 2 years of service to participate, all contributions are immediately vested. All
participants must be vested according to plan terms.


Nondiscrimination

To preserve the tax benefits of a profit sharing plan, the plan must provide substantive benefits for rank-and-file employees, not just business owners and managers. These requirements are called nondiscrimination rules and compare both plan participation and contributions of rank-andfile employees to owners/managers. Traditional profit sharing plans are subject to annual testing to ensure that the amount of contributions made for rank-and-file employees is proportional to contributions made for owners and managers. If you allocate a uniform percentage of compensation to each participant, then no testing is required because your plan automatically satisfies the nondiscrimination requirement.


Investing Profit Sharing Plan Monies

After you decide on a profit sharing plan, you can consider the variety of investment options. One decision you will need to make in designing a plan is whether to permit your employees to direct the investment of their accounts or to manage the monies on their behalf. If you choose the former, you also need to decide what investment options to make available to the participants. Depending on the plan design you choose, you may want to hire someone either to determine the investment options to make available or to manage the plan’s investments. Continually monitoring the investment options ensures that your selections remain in the best interests of your plan and its participants.


Fiduciary Responsibilities

Many of the actions needed to operate a profit sharing plan involve fiduciary decisions. This is true whether you hire someone to manage the plan for you or do some or all of the plan management yourself. Controlling the assets of the plan or using discretion in administering and managing the plan makes you or the entity you hire a plan fiduciary to the extent of that discretion or control. Hiring someone to perform fiduciary functions is itself a fiduciary act. Thus, fiduciary status is based on the functions performed for the plan, not a title.

Some decisions for a plan are business decisions, rather than fiduciary decisions. For instance, the decisions to establish a plan, to include certain features in a plan, to amend a plan, and to terminate a plan are business decisions. When making these decisions, you are acting on behalf of your business, not the plan, and therefore, you would not be a fiduciary. However, when you take steps to implement these decisions, you (or those you hire) are acting on behalf of the plan and thus, in making decisions, may be acting as fiduciaries.

Basic Responsibilities
Those persons or entities that are fiduciaries are in a position of trust with respect to the participants and beneficiaries in the plan. The fiduciary’s responsibilities include:

  • Acting solely in the interest of the participants and their beneficiaries;
  • Acting for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan;
  • Carrying out duties with the care, skill, prudence, and diligence of a prudent person familiar with such matters;
  • Following the plan documents; and
  • Diversifying plan investments.

These are the responsibilities that fiduciaries need to keep in mind as they carry out their duties. The responsibility to be prudent covers a wide range of functions needed to operate a plan. Since all these functions must be carried out in the same manner as a prudent person would, it may be in your best interest to consult experts in various fields, such as investments and accounting.

The plan must designate a fiduciary, typically the trustee, to make sure that contributions due to the plan are transmitted. If the plan and other documents are silent or ambiguous, the trustee generally has this responsibility. As part of following the plan documents in operating your plan, the plan document will need to be updated from time to time for changes in the law.

Limiting Liability

With these responsibilities, there is also some potential liability. However, there are actions you can
take to demonstrate that you carried out your responsibilities properly as well as ways to limit your
liability.

The fiduciary responsibilities cover the process used to carry out the plan functions rather than simply the results. For example, if you or someone you hire makes the investment decisions for the plan, an investment does not have to be a “winner” if it was part of a prudent overall diversified investment portfolio for the plan. Since a fiduciary needs to carry out activities through a prudent process, you should document the decision-making process to demonstrate the rationale behind the decision at the time it was made.

In addition to the steps above, there are other ways to limit potential liability. The plan can be set up to give participants control of the investments in their accounts. For participants to have control, they must have sufficient information on the specifics of their investment options. If properly executed, this type of plan limits your liability for the investment decisions made by participants. You can also hire a service provider or providers to handle some or most of the fiduciary functions, setting up the agreement so that the person or entity then assumes liability.


Disclosing Plan Information to Participants

Plan disclosure documents keep participants informed about the basics of plan operation, alert them to
changes in the plan’s structure and operations, and provide them a chance to make decisions and take
timely action about their accounts.

The summary plan description (SPD) – the basic descriptive document – is a plain-language
explanation of the plan and must be comprehensive enough to apprise participants of their rights and
responsibilities under the plan. It also informs participants about the plan features and what to expect
of the plan.

Among other things, the SPD must include information about:

  • When and how employees become eligible to participate in the profit sharing plan;
  • The contributions to the plan;
  • How long it takes to become vested;
  • When employees are eligible to receive their benefits;
  • How to file a claim for those benefits; and
  • Basic rights and responsibilities participants have under the Federal retirement law, the Employee Retirement Income Security Act (ERISA).

The SPD should include an explanation about the administrative expenses that will be paid by the plan. This document must be given to participants when they join the plan and to beneficiaries when they first receive benefits. SPDs must also be redistributed periodically during the life of the plan.

A summary of material modification (SMM) apprises participants of changes made to the plan or to the information required to be in the SPD. The SMM or an updated SPD must be automatically furnished to participants within a specified number of days after the change.

An individual benefit statement (IBS) shows the total plan benefits earned by a participant, vested benefits, the value of each investment in the account, information describing the ability to direct investments, and (for plans with participant direction) an explanation of the importance of a diversified portfolio. Plans that provide for participant-directed accounts must furnish quarterly individual benefit statements. Plans that do not provide for participant direction must furnish statements annually.

As noted above, for plans that allow participants to direct the investments in their accounts, plan and investment information, including information about fees and expenses, must be provided to participants before they can first direct investments and generally annually thereafter – with information on the fees and expenses actually paid provided at least quarterly. The initial plan-related information may be distributed as part of the SPD provided when a participant joins the plan as long as it is provided before the participant can first direct investments. The information provided quarterly may be included with the IBS.

A summary annual report (SAR) is a narrative of the plan’s annual return/report, the Form 5500, filed with the Federal Government (see Reporting to Government Agencies for more information). It must be furnished annually to participants.

A blackout period notice gives employees advance notice when a blackout period occurs, typically when plans change recordkeepers or investment options, or when plans add participants due to corporate mergers or acquisitions. During a blackout period, participants’ rights to direct investments, take loans, or obtain distributions are suspended.


Distributing Plan Benefits

The amount of benefits in a profit sharing plan is dependent on a participant’s account balance at the
time of distribution.

When participants are eligible to receive a distribution, profit sharing plans typically provide that
participants can elect to:

  • Take a lump sum distribution of their account,
  • Roll over their account to an IRA or another employer’s retirement plan, or
  • Take periodic distributions.

More employers are offering annuity or other lifetime income distribution options in their defined
contribution plans for employees who want to ensure that they do not outlive their retirement savings.
You may want to look into what other employers are doing.

 
 


Find out if a Profit Sharing Plan makes sense for your business,
contact Vermillion Financial Advisors today.

Request Appointment