Retirement through Profit Sharing It’s something that most of us don’t think we need to worry about until we get older. Retirement is also something that most of us don’t think we can worry about right now. After all, we have student loans, expensive healthcare costs, rising housing prices, kid’s college, aging parents, and a host of other financial worries that usually push the idea of retirement to the back of our mind. Additionally, retirement can be overwhelming. Most people have no idea what to invest in, how the investing process works, what tax implications our decisions may have, and most of all; how much money do you need to retire. 

While all of these questions will be answered in future articles, this article will start on the ground floor with the question: What are the different types of retirement plans? There are several different types of retirement plans and in this article, we will be addressing #9: Profit Sharing Plans. These articles will give you an idea of what to look for when deciding on how to save for retirement and what type(s) of retirement accounts to save in.

Types of Retirement Plans

1. Traditional IRA
2. Roth IRA
3. 401(k)
4. 403(b)
5. SIMPLE IRA
6. Simplified Employee Pension (SEP)
7. Salary Reduction Simplified Employee Pension Plan (SARSEP)
8. Payroll Deduction IRA
9. Profit Sharing Plan (this article)
10. Defined Benefit Plan
11. Money Purchase Plan
12. Employee Stock Ownership Plan (ESOP)
13. Thrift Savings Plan (TSP)
14. 457 Plan

IMPORTANT: READ THIS BEFORE CONTINUING

Before we get into the types of retirement accounts, it is important to make one key distinction. A retirement account, itself, is not an investment. If you say something to the extent of, “My 401(k) hasn’t done very well this past year and I’m thinking of picking a different one” you would be making an incorrect statement.

Think of it like this: There are 14 different types of retirement accounts (we will discuss the other 13 in different articles). Each one of those retirement accounts should be thought of as a cooking pot. If you cook something in that pot and you don’t like what it tastes like, you don’t dump the contents into another pot and hope that it tastes better. You change the ingredients of that pot to something else. Now think of the ingredients as different investment products (stocks, bonds, cash, mutual funds, and/or a host of other products/ingredients).To get the taste you want, you change the ingredients, not the pot. You may be wondering, what ingredients do I put into my pot? That is a fair question, but you cannot answer that question until you figure out what pot is best for you. Now buckle up and find out what the 14 different types of retirement accounts (pots) you have at your disposal.

Credit: Nicholas Gras: https://unsplash.com/@armgd

(9) Individual Retirement Arrangement (IRA)

A profit sharing plan is a retirement account that is a little different from any of the other retirement accounts that we will be discussing in other articles.. It is money that has been put into an account to be used for one’s retirement savings. profit sharing plans are retirement accounts that employers only contribute to based on how successful the company that you work for was during the previous period. Don’t overthink what a profit sharing plan is. It is exactly what it sounds like.

A profit sharing plan is a retirement account in which your employer will share some of their profits with the employees of the company. In a profit sharing plan, the employee will never contribute anything, only the employer will.

Remember earlier when I described the different pots? A profit sharing plan is simply a kind of pot. Within that pot, you can have different ingredients (investments).

Within a profit sharing plan you can have many different investments such as:

1. Stocks
2. Bonds
3. Mutual funds
4. Unit investment trusts
5. Government securities (Treasury bills, treasury notes, and treasury bonds)
6. US government-issued gold and silver coins. 

If you don’t know what all of these different terms mean, that is perfectly fine. Just know that you can have nearly all investment within a profit sharing plan.

But, there are a few items that cannot be in a profit sharing plan. profit sharing plans cannot have:

1. Antiques
2. Gems
3. Rare coins
4. Works of art
5. Life insurance contracts: This is because life insurance contracts are not securities (investments).
6. Municipal bonds: This is because putting a municipal bond in an IRA would negate the tax free status of the municipal bond.

Antiques, gems, rare coins, and works of art cannot be included in profit sharing plans because these items do not have a solid market value. Meaning: I might be willing to pay $50,000 for a painting, but you may be willing to only pay $3,000 for the same painting. It is too difficult to find an agreeable market value.

There are some stipulations to having an IRA that are important to know.

1. Contribution Limits (as of 2021): The contribution limit with a profit sharing plan is much different than any of the other retirement accounts. An employer can contribute a maximum of either $58,000 or 25% of total compensation (whichever is less). Also, the employer must contribute to each employee’s profit sharing plan based on the same formula. The formula that the employee can use is outside the scope of this article, but just know that they cannot give one employee nothing while giving another employee a bunch of money just because they don’t like the first employee.

2. Times to Contribute: A company can contribute to the profit sharing plans of its employees as often or infrequently as it deems necessary, so long as it does not exceed the contribution limits. Also, the company does not necessarily have to earn a profit to contribute money to the profit sharing plans of its employees (although, usually if the business does not make a profit, it will not contribute).

Just because the business gives money to the profit sharing plans of its employees during one year, does not mean that it is required to do the same the next year.

3. Contribution Tax Deduction Limits (as of 2021): Because the employee is not contributing anything to the profit sharing plan, there is no tax deduction for the employee to have.

4. Early Withdrawal (as of 2021): You should never take money out of a profit sharing plan until you are at least 59 ½. This is the most important consideration of a profit sharing plan (and any retirement account for that matter). This money is not there for you to buy a boat or go on a vacation, it is to retire with. If you take money out of a profit sharing plan before age 59 ½ you will pay taxes and a penalty of 10%. For example, if you are single and make $50,000/year and want to withdraw $10,000 from a traditional IRA, you will be taxed 22% ($2,200) + 10% penalty ($1,000). You will only come home with $6,800 (even though you withdrew $10,000) after taxes and the penalty. 

With most retirement accounts, there are a list of exceptions that you can qualify for to take money out of a retirement account before you reach 59 ½. However, there are no such exceptions with early withdrawals from a profit sharing plan before you are at least 59 ½. If you want to take money out early, you WILL pay the 10% penalty.

5. Spousal Profit Sharing Plan: There is no such thing as a spousal profit sharing plan. Remember, a profit sharing plan is the employer sharing some of the profits with the employees. That does not include the employee’s spouse.

I know that this is a lot of information but it is important to know what a profit sharing plan is, if it is appropriate for your situation, and how it can help you. You don’t necessarily have to understand the entire IRS rulebook regarding profit sharing plans, but I hope that you now have a better understanding of how they work. This is just one more way that you can exercise your Money Muscle and become a little more financially fit.

Until next time!