Profit-Sharing Plan vs 401(k): Which Employee Retirement Plan is Best?

If you’re interested in funding retirement accounts as a benefit for your employees, you’re on the right track in maintaining a loyal, satisfied workforce. When choosing between a profit-sharing plan vs 401(k), you can’t make a bad choice. In fact, you don’t have to choose at all. As a company, you’re permitted to both fund a profit-sharing plan and sponsor a 401(k) plan at the same time. As we'll discuss, you can even combine the two plans. 

If you’re curious about the differences between the retirement plans and want to compare the two, Axcet HR Solutions’ employee benefits consultants have answers. In this post, we’ll break down the differences between these popular plans and help you determine what course of action is best for your organization. 

What is a Profit-Sharing Plan? 

A profit-sharing plan is a tax-advantaged retirement account un by an employer for their employee. The employer is the only party who can contribute to the account—the employees themselves do not contribute but may maintain other personal retirement accounts. 

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How Does a Profit-Sharing Plan Work? 

When an organization maintains a profit-sharing plan as a retirement benefit for its employees, it contributes to the employees’ accounts in a uniform, pre-determined way. There are several methods of allocating profit-sharing plan contributions. 

The organization may decide, for example, that it will contribute 5% of each employee’s salary, or 7% of all of the organization’s profits to the employees’ accounts in accordance with the employee’s salary.

It’s common for employers to utilize the “comp-to-comp” method of calculating profit share plan contributions for each employee. The comp-to-comp method involves allocating a total sum of money (i.e., 5% of an organization’s profits) to employees based on the proportion their salary represents of the company’s total payroll. 

While the name of the plan implies that the contribution percentage must be based on the organization’s profits, that isn’t necessarily true. Employers may also choose to award employees company stock rather than cash. 

Benefits of Profit-Sharing Plans for Employers 

Businesses of any size may participate in profit-sharing plans. Many employers believe their team members are motivated by profit-sharing plans and are encouraged to achieve greater results for the organization in order to increase contributions. 

There are also potential tax benefits to contributing to profit-sharing plans. Employers may be able to deduct compensation paid during the taxable year to participants from their corporate taxes—check on your ability to deduct your contributions with an experienced employee benefits consultant. 

According to the Internal Revenue Service (IRS), as of 2024, employers may contribute the lesser of 100% of an employee’s compensation or $69,000.00. This figure is subject to adjustment in subsequent years based on the cost of living and has gone up each year in recent records. There is no minimum for how much money employers should contribute to profit-sharing plans. 

Note: Employers that decide to offer profit-sharing plans must file a Form 5500 each year. 

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Profit-Sharing Plan vs 401(k): What's the Difference? 

When deciding whether to offer a profit-sharing plan, an employer-sponsored 401(k), or both, it’s helpful to understand the plans’ key similarities and differences. Consider the following: 

How Profit-Sharing and 401(k) Plans Differ 

• Contribution mechanisms

  Contributions are made differently in profit-sharing plans vs 401(k) accounts. In a profit-sharing plan, the employer contributes a predetermined amount of money to the employee’s retirement account.
   
  With a 401(k), an employee can determine how much they’d like to contribute (within certain limits), and employers may match their contributions up to a certain percentage. 

• Contribution limits

  Depending on an employee’s compensation, higher contributions may be made to profit-sharing accounts than 401(k) plans. 
  
  While profit-sharing plans are capped at the lesser of 100% of an employee’s compensation or $69,000.00 in 2024, 401(k) plan contributions are usually capped at $23,000.00 for tax-deductible contributions. 

• Vesting periods

  With profit-sharing plans, contributions are commonly subject to vesting schedules, meaning that employees may not be able to access funds until they’ve served certain pre-set lengths of tenure with the company. 
  
  While employer contributions to 401(k) plans may be subject to vesting schedules, employee contributions are often immediately fully vested and accessible to employees. 

How Profit-Sharing and 401(k) Plans Are Alike 

• Tax advantages

  Both types of retirement plans are both tax-advantaged and offer tax-deferred growth. Contributions to either type of plan are made on a pre-tax basis. 

• Investment structure

  Both types of retirement accounts have the same basic structure: they are investment portfolios holding a mix of securities assets and include stocks, bonds, ETFs, mutual funds and so on. 

• Roll-over abilities

  Both types of retirement plans offer employees the ability to roll over their funds into another qualified retirement account. This means that if they leave their employment with you, they can bring vested funds with them. 

Combining Profit-Sharing Plans and 401(k)s

While it’s possible to offer a standalone profit-sharing plan or 401(k) plan, combining profit-sharing and 401(k) plans is a popular way to give your employees the benefits of both types of retirement accounts. 

Employees can reap the rewards of their own contributions to a 401(k) plan, and give themselves a level of predictability and reliability through their own 401(k) funding—and your organization’s potential match amounts. When combined with a profit-sharing plan, employees can also benefit directly from the success of the company and may be incentivized to push harder toward the achievement of organizational goals as a result. 

Combining profit sharing and 401(k) plans can also help employers cut back on the burden involved in plan administration. 

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Ready to Revisit your Retirement Benefits? Axcet HR Solutions can Help 

At Axcet HR Solutions, we believe that employees of all organizations should have access to Fortune 500-level benefits and that offering these benefits should be affordable for small to mid-sized businesses. 

When you partner with Axcet, you’ll find experts on your side who are dedicated to locating the right benefits for your organization, its employees, and its unique culture. Interested in learning more about the retirement benefits options your business can provide to its employees? Schedule a consultation with the experienced employee benefits consultants at Axcet HR Solutions today.