CARL WATTS & ASSOCIATES
November 29, 2010
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Washington DC
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tel/fax 202 350-9002 |
Profit Sharing Plans
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These are qualified retirement plans established by employers to provide retirement benefits to their employees, based on employer contributions only.
The good part is there is no actual need for profits to make contributions to a profit sharing plan, but contributions are discretionary, as long
as they are the lesser of 25% of compensation or $49,000 for 2010 and 2011, as capped by the IRS.
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If you participate in a profit sharing plan you probably know that your employer must follow a strict set of rules to demonstrate that the plan covers all employees equally and that benefits are given to participants in an acceptable and fair way. Contributions to the plan may be of a fixed amount or a percentage of your annual salary and may be based on age and service.
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You could participate in a profit sharing plan as a part of a combined plan with a 401(k) which allows you to make contributions as well. All funds contributed to your accounts are on a tax-deferred basis.
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The contributions your employer makes to your plan, along with the plan’s earnings from investments, accumulate untaxed. Distributions will be taxed as common income after retirement.
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Some plans allow for early withdrawals, but that means loosing the tax deferred benefit and paying the 10% tax penalty. Hardship withdrawals and loans are possible, too.
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Profit sharing plans used to be combined with money purchase plans because of the benefit of high contribution limits and a degree of flexibility in determining the amount of each year’s contributions.
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In a money purchase plan your employer is required to contribute a fixed percentage of your salary to your personal account annually.
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With the changes in the law under the Economic Growth and Tax Relief Reconciliation Act (EGTRRA 2002), money purchase plans have started to become a thing of the past.
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Stock Bonus Plans & Employee Stock Ownership Plans (ESOP)
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The stock bonus plan is a version of the profit sharing plan, with the main difference being that instead of direct funds, your employer gives you shares.
As is always the case with qualified retirement plans, there are strict rules with stock bonus plans.
As a participant in a stock bonus plan you must pass through voting rights on the stock held by the plan and must have the ability to demand that your employer buy back the securities if the stock is not publicly traded. Your employer must distribute the stock within one year of retirement, death or disability, or within five years if you are terminated as an employee but still eligible. |
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Stock bonus plans can be a good deal for you as an employee if the company has a steady increase in growth and profit, but are not guarantees for money and can vary greatly from year to year. Your employer has a choice whether or not to place any money in your stock bonus plan, and in a bad year they might choose to not grant any stock.
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The employee stock ownership plan is a stock bonus plan that invests corporate profits back into the stock of the sponsoring employer by rewarding employees with company stock.
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As with profit sharing plans or money purchase plans, contributions are capped at the lesser of 25% of your annual salary or $49,000.
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Basically an ESOP is a trust wherein shares of the company are purchased in your name as an employee and held by the trustee until you retire or leave the company. The company can provide the trust money to buy more stocks or issue new shares to place them under the control of the trust.
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There are two types of ESOPs depending on whether the money contributed to the trust is borrowed or not.
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In a non-leveraged (not borrowed) ESOP, stock or cash is regularly contributed to the trust, although the amount may vary from year to year at the discretion of your employer. This type is similar to other pension plans except that only the stock from your employer’s company is purchased.
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In a leveraged ESOP, shares are purchased with borrowed money which is used to buy out existing shareholders or invest back into the business. As the loan is paid off, the stock is transferred to your account.
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Distributions from your ESOP may be made in a lump sum or in installments over a period of years. In most cases ESOP contributions vest 100% after 5 years. Vesting may also occur based on the number of years of your employment with the company; for instance, you may have to be with the company for at least three years before vesting can begin.
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No matter the plan you participate in, make sure you check with your HR department to understand your entitlement, and, even better, ask for professional help as well.
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