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Profit-Sharing Contributions

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Profit-sharing contributions are employer-funded contributions made to employees’ 401(k) accounts. These contributions are optional and allocated annually during nondiscrimination testing to ensure they meet IRS nondiscrimination rules.

How Are Profit-Sharing Contributions Allocated?

The plan document specifies how profit-sharing contributions are distributed among employees. The chosen allocation method affects nondiscrimination testing and must be followed as outlined in the plan. Common profit-sharing methods include:

  • Pro-Rata Allocation: Every eligible employee receives a contribution equal to a fixed percentage of their compensation, ensuring equal treatment across all participants. This is the most common profit sharing allocation.
  • New Comparability (Cross-Tested): Contributions vary between employee groups, allowing employers to provide higher contributions to certain groups (such as key employees or highly compensated employees(HCEs)). This method requires additional nondiscrimination testing for 401(k) plan compliance. This option is only available at Betterment to Pro and Flagship plans.
  • Integrated (Permitted Disparity): Employees earning above the Social Security wage base receive higher contributions than those earning below it, aligning with IRS-permitted contribution differences. This option is only available at Betterment to Pro and Flagship plans.

Employers should review their plan document to confirm the correct allocation method and report the intended budget in the compliance questionnaire to ensure proper testing and funding.

How to Report Profit-Sharing Contributions

The compliance questionnaire includes a section where employers should enter their profit-sharing budget or intended allocation. This helps ensure the contributions are included in testing and allocated correctly.

Key Deadlines and Compliance Considerations

  • Profit-sharing contributions must be funded by the company’s tax filing deadline, including extensions, to qualify for a tax deduction in that year.
  • Contributions must pass nondiscrimination testing to confirm they do not disproportionately benefit HCEs.

Accurately reporting and planning for profit-sharing contributions helps ensure compliance and maximizes the benefit for employees.