Contributions: Employer Contributions
The formula used in your plan to determine the allocation of employer contributions is determined by the type of plan (e.g., profit sharing, defined contribution pension — also known as money purchase pension) and your elections in Section 4 of the adoption agreement.
Employer contributions to a profit sharing plan are discretionary; that is, you elect each year whether to make a contribution and, if so, the amount of such contribution. Although the contribution amount is discretionary, you must allocate the contribution to eligible participants according to the options you have elected in the adoption agreement.
Employer contributions to a defined contribution pension plan (also known as a money purchase pension plan) are mandatory, not discretionary. When you adopt a money purchase pension plan, you commit to making an annual contribution that is a fixed percentage of participants’ compensation and which you are obliged to make by law.
If you have a money purchase pension plan or a target benefit plan, it is important to know that you are required to make the exact contribution amount indicated in the adoption agreement every year. If your firm decides to amend your plan to increase or decrease the contribution level, you must notify your plan participants at least 15 days prior to the effective date of the amendment for plans with fewer than 100 participants. Plans with more than 100 participants must notify plan participants at least 45 days prior to the effective date of the amendment. Please contact us for assistance in amending your plan and providing the proper notice to participants if this becomes necessary.
The employer contribution allocation formulas for both profit sharing and money purchase pension plans may include some of the following provisions:
Profit Sharing Plan
- Pro-rata to each eligible participant according to the ratio of his or her eligible compensation to the eligible compensation of all eligible participants;
- “Integration” with Social Security, under which eligible participants whose eligible compensation exceeds the Social Security Taxable Wage Base or some defined fraction thereof receive allocations that exceed, by a certain percentage, the allocations credited to other eligible participants;
- Uniform points formula where contributions will be allocated pro-rata to each eligible participant according to the ratio of his or her total points to the total points of all eligible participants. Under this formula, eligible participants can receive points for age and/or service;
- Contributions to a profit sharing plan are discretionary.
Defined Contribution (Money Purchase) Pension Plan
- A certain percentage of the eligible compensation (not to exceed 25%) of each eligible participant;
- “Integration” with Social Security, under which eligible participants whose compensation exceeds the Social Security Taxable Wage Base or some defined fraction thereof receive allocations that exceed, by a certain percentage, the allocations credited to other participants;
- Contributions to a defined contribution (money purchase) pension plan are mandatory.
Age-Weighted and New Comparability Plans
Allocations under this category of plans are not strictly based on compensation. In an age-weighted plan, older employees receive higher allocations. A new comparability plan — also known as a “cross-tested” plan — enables favored classes of employees to receive higher allocations. These types of plans require complex testing and contribution calculations. These allocations are only available for non-standardized profit sharing plans with a 401(k) arrangement (adoption agreement 01-004).
Quick Tips for Calculations
- Check to see if the participant has met the requirements to receive a contribution in accordance with elections in the adoption agreement (e.g., was participant employed at the end of his or her taxable year?).
- Make sure contributions to all of your plans don’t violate the annual additions limit (Section 415 of the Internal Revenue Code) for each participant (see Contribution Limits).
- Check that the participant’s elective contributions (including pre-tax elective contributions and Roth 401(k) contributions) are not greater than the IRS annual deferral dollar limit ($19,500 in 2019). If the participant has reached age 50 by the end of the plan year, however, his or her deferrals plus catch-up contributions are limited to the IRS annual deferral dollar limit plus the annual limit on catch-up contributions ($6,000 in 2019, for a total of $25,000 in 2019).
- Factor in the salary caps ($280,000 in 2019).
- Factor in compensation dates (e.g., entry date or full year).