The Pros and Cons of Offering Profit-Sharing in a 401(k) Plan
What if your company could reward employees, reduce taxes, and retain top talent, all through one smart strategy? That’s the power of profit-sharing within a 401(k) plan.
Profit-sharing isn’t just for large corporations with high margins. With the right plan design and support, businesses of all sizes can use profit-sharing contributions to build goodwill, increase retirement savings, and strengthen their bottom line.
In this article, we’ll break down how profit-sharing works, highlight its benefits and drawbacks, and help you determine whether it’s a good fit for your business.
What Is Profit-Sharing in a 401(k) Plan?
A profit-sharing contribution is an optional employer contribution made to employees’ retirement accounts, regardless of whether the employee contributes to the plan. It allows employers to share the company’s financial success while gaining tax advantages.
These contributions are made at the discretion of the employer and may vary from year to year based on company performance or strategic planning.
Key facts:
- Employers can contribute up to 25% of total eligible compensation, with a cap of $69,000 per participant in 2025 (or $76,500 with catch-up contributions).
- Contributions are tax-deductible for the business and grow tax-deferred for employees.
- Employers can decide how much to contribute, and which employees receive contributions, within IRS limits.
How Profit-Sharing Contributions Work
Unlike matching contributions, which are tied to how much an employee contributes, profit-sharing contributions are entirely funded by the employer and do not depend on employee deferrals.
Employers can choose from different allocation methods, such as:
- Pro-Rata: A fixed percentage of compensation is contributed to all eligible employees.
- Integrated with Social Security: Higher earners receive a larger contribution, coordinated with Social Security benefits.
- New Comparability (or Cross-Tested): Allows employers to favor specific employee groups (often owners or executives) while staying within IRS limits.
Each method must pass nondiscrimination testing to ensure fair treatment of all employees. Maxus Plan Solutions can help ensure your plan stays compliant.
✅ Flexible Contributions – Employers are not required to contribute every year. You can adjust contributions based on profitability.
✅ Tax Advantages for Employers – Contributions are tax-deductible, reducing your business’s taxable income, which is especially helpful during high-earning years.
✅ Boosts Employee Morale and Retention – Sharing profits builds employee trust and loyalty while also supporting retention and enhancing your company culture.
✅ Improves Retirement Readiness – Employees receive additional retirement savings, even if they do not contribute, supporting their long-term financial security.
✅ Increases Owner Savings – Strategic plan design can help owners and key employees maximize their own contributions.
Drawbacks of Offering Profit-Sharing
⚠️ Must Pass Nondiscrimination Testing – All profit-sharing contributions must comply with IRS rules, which may require corrective actions or lost tax advantages if not met.
⚠️ Requires Careful Plan Design – Choosing and ineffective plan desing can lead to inefficiencies or missed savings opportunities.
⚠️ May Confuse Employees – Because contributions are discretionary, some employees may expect them annually and feel disappointed when they are not offered.
⚠️ Adds Administrative Complexity – Designing and administering a profit-sharing formula requires coordination with your plan provider to ensure compliance and reporting accuracy.
Is Profit-Sharing Right for Your Business?
Profit-sharing can work for:
- Small businesses looking to reward loyal employees and reduce taxes.
- Growing companies wanting to stay competitive with larger firms.
- Large businesses aiming to retain talent while providing strategic compensation alternatives.
The key is having the right partner to ensure the plan is designed and tested properly, and that’s where Maxus Plan Solutions comes in.
How Maxus Plan Solutions Can Help
At Maxus Plan Solutions, we specialize in helping business owners design and manage cost-effective retirement plans that fit your goals and your team.
Our services include:
- Plan design consulting to build the right profit-sharing formula
- IRS compliance testing and correction support
- Ongoing administrative support and operational assistance
- Payroll integration and contribution reporting tools
We don’t sell investments. We don’t offer financial advice. We focus exclusively on plan design, administration, and compliance, so you can offer competitive benefits without stress.
Final Thoughts
Profit-sharing is more than a bonus; it’s a strategic retirement tool that can elevate your 401(k) plan and your company.
Whether you’re running a small business or a multi-location enterprise, the right plan can help you share success and build a loyal, financially secure team.
Let Maxus Plan Solutions help you explore the possibilities. Contact us today for a customized consultation.