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Everything You Need To Know

Profit Sharing Plan

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Video Overview | Page last updated July 2024

A profit sharing plan is an employer sponsored retirement plan in-which your employer makes contributions (typically based on profits) to an investment account that you will then typically manage for yourself. It is much like a 401(k) plan except you (the employee) don’t make any contributions to the retirement plan. It solely relies upon your employer for contributions. That is not to say a profit sharing plan can’t be combined with a 401(k), because many retirement plans are designed that way, it’s just that a stand alone profit sharing plan relies upon employer contributions only.  There are many benefits, both for your employer and yourself, when your company sponsors a profit sharing plan. The contributions your employer makes to a profit sharing plan are generally tax deductible for the company while the contributions rewarded to you (the employee) enjoy tax deferred benefits.

If your employer sponsors a profit sharing plan, you will most likely encounter three various types of allocation methods. The most common ones are traditional (sometimes referred to as pro-rata or comp-to-comp), integrated (sometimes referred to as permitted disparity or social security integration) and new comparability (sometimes referred to as cross-testing). Your employer has discretion on how and when to allocate profit sharing contributions but the one thing they can’t do is discriminate in favor of highly compensated employees.  Profit sharing plans must pass a variety of complicated tests to ensure that they do not discriminate.

Your profit sharing plan could be a cornerstone of your financial future. To maximize its benefits, we encourage you to periodically review its features and performance. The Summary Plan Description (SPD), provided to all participants, contains critical details such as eligibility requirements, contribution limits, investment options, and vesting schedules. Familiarizing yourself with these elements empowers you to make strategic decisions about your retirement. For personalized support regarding your SPD or profit sharing plan, we invite you to schedule a consultation for expert, tailored guidance.

Contributions

Eligibility 丨 Entry Date 丨 Annual Limits 丨 Employer 丨 Vesting 丨 Rollovers 丨 Inheritance & Death

If your employer sponsors a standalone profit sharing plan—without combining it with a 401(k)—your account will consist solely of employer contributions, as employee contributions are not permitted. The value of your account hinges on two factors: the amount your employer contributes and the performance of your chosen investments. Employers are not obligated to contribute annually, affording them flexibility based on profitability or strategic priorities. However, contributions must be “recurring and substantial”—typically made in at least three out of five years—to maintain the plan’s active status. Failure to meet this threshold may lead the IRS to deem the plan terminated, potentially impacting your vesting schedule.

When contributions are made, they must be deposited into your account by the employer’s tax filing deadline, generally April 15 for calendar-year filers, or October 15 if an extension is filed. All employees meeting the plan’s eligibility criteria will receive that year’s profit sharing allocation, distributed according to the plan’s designated method. Eligibility and allocation details are outlined in your Summary Plan Description (SPD), which we encourage you to review.

Plan Eligibility

Eligibility refers to the conditions you (the employee) must meet to participate in the profit sharing plan, as determined by the plan sponsor (your employer). Generally, you must be allowed to participate if you meet these two requirements:

  • Age: You must be at least 21 years old.
  • Service: You must have completed at least one year of service (generally defined as 1,000 hours worked within a 12-month period.)

Your employer can choose to relax or remove these age and service requirements, making participation easier. The specific eligibility rules will be detailed in your plan documents and SPD, so review those carefully. Once you satisfy all eligibility requirements, that date becomes your initial eligibility date, and you’ll begin participating in the plan on the next available entry date (as defined by the plan).

Plan Entry Date

Once you satisfy the age and service eligibility requirements, federal regulations limit how long your employer (the plan sponsor) can delay your participation in the profit sharing plan. An eligible employee must begin participating no later than the earlier of:

  • The first day of the next plan year beginning after the date you satisfy the minimum age and service requirements, or
  • Six months after the date you satisfy those requirements.

For plans operating on a calendar year, many employers adopt dual entry dates—such as January 1 and July 1—to comply with the six-month maximum waiting period. Some plans offer more frequent entry options, including quarterly, monthly, or even immediate (daily) entry, depending on the employer’s design. To confirm the specific entry date rules for your plan, consult your plan documents and SPD.

Contribution Limits

The employer’s tax-deductible contributions to a profit sharing plan are limited to 25% of the total compensation (up to the annual compensation limit) paid to all eligible employees participating in the plan. For an individual employee, the maximum contribution that can be allocated to your account each year is the lesser of 100% of your compensation or the annual limit detailed below:

↳ For Tax Year 2025

Contribution Limits
Total Contribution Limit $70,000
Annual Compensation Limit $350,000
Highly Compensated Employee (HCE) Limit $160,000
  • Total contribution limits include all sources from deferrals, matching and profit sharing contributions

↳ For Tax Year 2024

Contribution Limits
Total Contribution Limit $69,000
Annual Compensation Limit $345,000
Highly Compensated Employee (HCE) Limit $155,000
  • Total contribution limits include all sources from deferrals, matching and profit sharing contributions

Employer Contribution

Profit sharing contributions are discretionary, meaning your employer can vary the contribution amounts from year to year based on their discretion. If a contribution is made, your employer must specify a formula for dividing it among employees, and this will be outlined your SPD and plan documents. While a formula must be defined, your employer has flexibility to adjust it by amending the plan, allowing them to adapt to evolving business needs. Many plans also include a “last day provision”, requiring you to be employed on the final day of the plan year—typically December 31 for calendar-year plans—to receive that year’s contribution.

All profit sharing contributions are made pre-tax, providing tax benefits to both parties: employers can deduct contributions as a business expense (up to IRS limits), while your account benefits from tax-deferred growth until withdrawal. Common allocation formulas you may encounter include:

↳Traditional Profit Sharing Formula

The traditional profit sharing formula, also known as pro-rata or comp-to-comp, allocates contributions as a uniform percentage of each eligible employee’s compensation. This method ensures all participants receive the same percentage of their pay, promoting equitable distribution.

EXAMPLE:If your employer sets a contribution rate of 6% and your compensation is $100,000, your pro-rata allocation would be $6,000 (6% × $100,000).

Alternatively, the formula can be applied by comparing individual compensation to the total compensation of all eligible employees. Your employer calculates the total compensation (“total comp”) for the group, then divides each employee’s compensation (“employee comp”) by this amount to determine their share of the profit sharing pool

EXAMPLE:Consider three employees with a $20,000 profit sharing pool and total compensation of $300,000:

  • Tyler earns $80,000: ($80,000 ÷ $300,000) × $20,000 = $5,333 (approximately 6.67% of pay).
  • Eliza earns $100,000: ($100,000 ÷ $300,000) × $20,000 = $6,667 (approximately 6.67% of pay).
  • Aaron earns $120,000: ($120,000 ÷ $300,000) × $20,000 = $8,000 (approximately 6.67% of pay).

In both approaches, the result is proportional, with allocations reflecting each employee’s compensation relative to the group. Your specific allocation will depend on the formula detailed in your Summary Plan Description (SPD).

↳ Integrated Profit Sharing Formula

The integrated profit sharing formula, also known as social security integration or permitted disparity, adjusts contributions based on the social security taxable wage base (SSTWB). The IRS allows this disparity because social security benefits accrue at a reduced rate for compensation above the SSTWB ($168,600 for 2024), enabling employers to provide higher contributions on excess compensation for those earning more. As a result, employees with compensation below the SSTWB receive a uniform percentage of their pay, while those above receive a larger effective allocation on the excess (within IRS limits).

Under an integrated profit sharing plan, the contribution rate applied to excess compensation cannot exceed the lesser of: (1) the base contribution rate applied to total compensation or (2) the maximum permitted disparity percentage – which is based on the plan’s integration level shown below:

Integration Level Max Permitted Disparity
100% of the SSTWB 5.7%
More than 80% but less than 100% of SSTWB 5.4%
More than 20% but less than 80% of SSTWB 4.3%
20% or less of the SSTWB 5.7%

EXAMPLE: The company has three employees. Tyler gets paid $80,000 / Eliza gets paid $100,000 / Aaron gets paid $200,000.  The employer makes a 10% profit sharing contribution on total compensation. The employer also has a permitted disparity profit sharing contribution with a plan’s integration level at 100% of the SSTWB ($168,600 for 2024). The following employees would get:

Employee Total Compensation Contribution Rate Excess compensation Excess Rate Total Allocation
Tyler $80,000 10% $0 5.7% $8,000 = 10%
Eliza $100,000 10% $0 5.7% $10,000 = 10%
Aaron $200,000 10% $31,400 5.7% $21,789 = 10.89%

This formula balances fairness with increased benefits for higher earners, subject to IRS nondiscrimination rules. Check your SPD for your plan’s specific integration details.

↳ New Comparability Profit Sharing Formula

The new comparability profit sharing formula allows employers to allocate different contribution rates to distinct employee groups within a plan. Commonly, these groups distinguish owners from non-owners or highly compensated employees (HCEs) from non-highly compensated employees (NHCEs). Employers may also define groups using other reasonable, business-related criteria—such as job classification or division—provided the groupings do not disproportionately favor HCEs, per IRS rules.

This flexibility requires rigorous nondiscrimination testing to ensure fairness. The primary method, known as cross-testing (hence the term “cross-tested plans”), evaluates contributions by converting them into projected retirement benefits. Below is an overview of the process.

Gateway Minimum –Before cross-testing, a minimum “gateway” contribution is required for the non-targeted group (typically NHCEs) to prevent overly small allocations compared to the targeted group (e.g., HCEs). The gateway minimum is the lesser of:

  • 5% of compensation, or
  • 1/3 of the highest allocation rate given to any HCE in the plan year

Cross-testing Process – Once the gateway minimum is met, each participant’s contribution is cross-tested as follows:

  1. The participant’s contribution for the year is recorded.
  2. This amount is projected to the participant’s normal retirement age (typically 65, as defined by the plan) using a standard interest rate (usually 7.5%–8.5%, per IRS guidance, with 8.5% being common).
  3. The projected lump sum is converted into an annual benefit—a straight-life annuity payable at retirement—using actuarial factors (e.g., UP-1984 or GAR-94 mortality tables and the same interest rate).
  4. This annual benefit is divided by the participant’s compensation to calculate the Equivalent Benefit Accrual Rate (EBAR).

Younger employees typically have higher EBARs due to more years of compound growth, yielding a larger projected benefit relative to their pay. Older employees, nearing retirement, have lower EBARs for the same contribution amount due to less growth time.

General Test (Rate Group Testing) – The plan must pass the general test to confirm nondiscrimination through rate group testing:

  • Each HCE is assigned their own rate group.
  • All participants (HCEs and NHCEs) with an EBAR equal to or exceeding the HCE’s EBAR are included in that group.
  • Each rate group must pass one of two tests:
    • ➡ (1) The Ratio Percentage Test: For each HCE’s rate group, calculate the ratio by:
      • % of NHCEs benefiting (NHCEs in the group ÷ total eligible NHCEs)
      • % of HCEs benefiting (HCEs in the group ÷ total eligible HCEs)
      • Divide NHCE % by HCE % ; if the ratio is at least 70%, the group passes.
    • ➡ (2) The Average Benefit Test: If the ratio percentage test fails, the plan must pass two sub-tests:
      • Nondiscriminatory Classification Test: Groupings must be reasonable and not favor HCEs disproportionately.
      • Average Benefit Percentage Test: The average EBAR for all NHCEs must be at least 70% of the average EBAR for all HCEs across the plan (including non-benefiting participants).

Vesting Schedule

Vesting determines when you gain full ownership of the profit-sharing contributions your employer makes to your account. If you leave the company before becoming fully vested, the unvested portion reverts to the employer, potentially reducing your retirement savings upon a job change. Understanding your plan’s vesting schedule is critical for planning your financial future. Employer contributions typically vest based on your years of service, though full vesting may also occur upon plan termination or when you reach the plan’s normal retirement age. Below are the common vesting schedules for employer contributions:

↳ Immediate Vesting

With immediate vesting, you own 100% of your employer’s profit-sharing contributions as soon as they are deposited into your account. If you leave the company at any time, you retain the full amount, with no portion forfeited.

↳ Cliff Vesting

Under cliff vesting, you are 0% vested in employer contributions during an initial period—up to a maximum of three years for profit-sharing plans—then become 100% vested all at once after completing the required service. Some plans may use a shorter cliff, such as two years.

EXAMPLE –If your plan has a three-year cliff and you leave after 2 years and 11 months, you forfeit all employer contributions, as you haven’t reached the three-year threshold for full vesting.

↳ Graded Vesting

Graded vesting increases your ownership incrementally over time. A common schedule starts at 0% in the first year, then adds 20% vesting credit per year of service, reaching 100% after six years. This gradual approach provides a clear path to full ownership.

EXAMPLE – Tyler’s employer offers a profit-sharing plan with a 6-year graded vesting schedule, tracking vesting service based on calendar years. Tyler started working in June 2007 and left in August 2011. Under the plan, a year of service requires at least 1,000 hours worked. Tyler met this threshold in 2007, 2008, 2009, 2010, and 2011, accumulating 5 years of vesting service. As a result, he’s 80% vested in his employer’s contributions to his account.

Your specific vesting schedule is detailed in your SPD and plan documents. Review it to understand how your service impacts ownership of contributions.

Rollovers Into: Profit Sharing Plan

Rolling over funds into your profit sharing plan can offer benefits such as consolidating retirement accounts, reducing fees, or accessing enhanced investment options. A direct rollover—also called a trustee-to-trustee transfer—moves funds tax- and penalty-free, provided the transaction complies with IRS rules.

↳ Rollover Chart: Which Retirement Accounts Are Allowed To Be Rolled Into A Profit Sharing Plan

Type of Account Allowed?
Roth IRA No
Traditional IRA Yes
SIMPLE IRA Yes, after two year
SEP IRA Yes
Governmental 457(b) Plan Yes
Qualified Plan ₍₁₎ (pre-tax) Yes
403(b) Plan (pre-tax) Yes
Designated Roth Account (401(k), 403(b), or 457(b)) No

Additional information: (1)

(1) Qualified plans include profit-sharing, 401(k), money purchase, and defined benefit plans.

↳ Rollover a Old Profit Sharing Plan Over To A New Profit Sharing Plan

If you switch jobs and your new employer’s profit sharing plan permits rollovers, you may transfer funds from your previous employer’s plan. This is optional, as you can leave funds in the old plan after separation from service. Before proceeding, compare the investment options and fee structures of both plans to determine the best approach.

Consolidating into your new employer’s plan retains key profit sharing advantages over an IRA. For instance, if you’re over 73 and still working, you can delay Required Minimum Distributions (RMDs) until retirement. Additionally, rolling over avoids IRA pro-rata rules, simplifying strategies like backdoor Roth IRA contributions.

↳ Rollover Over A Traditional IRA To Your  Profit Sharing Plan (Reverse Rollover)

If your current profit sharing plan allows, you may roll funds from a traditional IRA into it—a process known as a reverse rollover. This option might appeal if you’re 73 or older and still employed, as it can delay RMDs until retirement. Other benefits include accessing plan loan provisions (if available) for tax- and penalty-free withdrawals or zeroing out IRA balances to facilitate a backdoor Roth conversion without pro-rata complications.

↳ More on Rollovers: Individuals Can Perform a Rollover in The Following Ways

  1. Direct rollover – An account holder must request instructions from their plan administrator. Typically, a check is made payable to the new 401(k) or IRA custodian (e.g., “Fidelity Investments FBO [Your Name]”) and sent directly to the new plan. No taxes are withheld from the transfer amount because the funds do not pass through the individual’s hands.
  2. Trustee-to-trustee transfer – The trustee or custodian of one plan transfers the rollover amount directly to the trustee or custodian of another plan. This is common for IRA-to-IRA transfers. No taxes are withheld, and the individual does not take possession of the funds.
  3. 60-day rollover – If a distribution from an IRA or retirement plan is paid directly to you (e.g., a check in your name), you can deposit all or a portion of it into an eligible retirement plan within 60 days. For distributions from a retirement plan like a 401(k), taxes (typically 20%) are withheld, so you’ll need to use other funds to roll over the full pre-tax amount. For IRA distributions, taxes are not automatically withheld unless requested.
    • Note: Only one IRA-to-IRA 60-day rollover is allowed per 12-month period (this limit does not apply to direct rollovers, trustee-to-trustee transfers, or rollovers involving employer plans).

Eligibility and rules for rollovers depend on your plan’s terms, detailed in your SPD and plan documents. Consult your plan administrator to confirm options and ensure compliance with IRS regulations.

Investments

As a participant in a profit-sharing plan, you are typically responsible for managing your account’s investments. This involves choosing from a lineup of options curated by your plan sponsor—usually your employer. The lineup often includes mutual funds, index funds, or a combination of both, designed to provide diversification and growth potential tailored to various risk profiles. Many plans also offer tools within their investment portals, such as automatic rebalancing, to help you maintain a portfolio aligned with your financial goals and risk tolerance. Details on available options and features are outlined in your SPD and plan documents.

Distributions

Overview 丨 Financial Hardship 丨 In-service 丨 Rule of 55 丨 RMDs 丨 Rollovers

Overview

Profit-sharing plans offer greater distribution flexibility for employer contributions compared to 401(k) plans, where employee deferrals and safe harbor matching contributions face strict in-service distribution rules. In a profit-sharing plan, vested contributions can be distributed at any time if permitted by the plan documents and you are fully vested. However, withdrawals before age 59½ may incur a 10% early withdrawal penalty unless an exception applies. Typically, a plan may permit distributions of your vested account balance when you:

  • Terminate employment (due to death, disability, retirement, or other separation);
  • Reach an age specified in the plan (which could be any age, not necessarily 59½); or
  • Experience a hardship or other event outlined in the plan documents.

While this flexibility may allow you to access funds before age 59½—unlike many 401(k) plans—the 10% penalty still applies to early distributions unless an exception is met. Below are the tax and penalty implications for distributions before and after age 59½.

↳ Distribution After Age 59½

After reaching age 59½, you can typically access your profit-sharing account balance, even if still employed, provided the plan documents allow it (the specific age may vary). These distributions are taxed at your ordinary income rate but are not subject to the 10% early withdrawal penalty.

↳ Distributions Before Age 59½

Before age 59½, access is generally restricted until you separate from the employer sponsoring the plan or reach the distribution age specified in the plan documents. If you withdraw funds early, the distribution is taxed at your ordinary income rate and incurs a 10% early withdrawal penalty, unless an exception applies.

10% Early Withdrawal Penalty Exceptions

The IRS provides several exceptions to the 10% penalty, including:

  • Distributions to a beneficiary or estate after the participant’s death.
  • Distributions due to a qualifying disability or terminal illness.
  • Payments as part of substantially equal periodic payments (SEPP) under IRS rules.
  • Distributions after separation from service, if the separation occurs in or after the year you turn 55.
  • Amounts used for medical expenses exceeding the allowable deduction threshold (IRC § 213).
  • Up to $5,000 per child for qualified birth or adoption expenses.
  • Up to $1,000 per year for a personal or family emergency (emergency personal expense distribution).
  • Funds used to pay an IRS levy.
  • and a few others

Financial Hardship

If you face financial hardship while enrolled in a profit-sharing plan, you may access funds to address immediate needs, depending on your plan’s provisions. These options—emergency distributions, hardship withdrawals, or loans—offer relief under specific conditions. Review your SPD and plan documents for availability and rules tailored to your plan.

↳ Emergency Personal Expenses Distribution (EPED)

If permitted by your plan, you may take one penalty-free Emergency Personal Expenses Distribution (EPED) per calendar year for unforeseeable personal or family emergencies. The maximum EPED is the lesser of:

  • $1,000
  • Your vested account balance minus $1,000.

You cannot take another EPED for three calendar years unless the prior distribution is repaid. While the 10% early withdrawal penalty is waived, the amount is taxable as ordinary income in the year received.

↳ Hardship Distribution

A hardship distribution allows withdrawal of vested funds to meet an immediate and heavy financial need, if your plan offers this option. The withdrawal must:

  • Address a qualifying financial emergency, and
  • Be limited to the amount required, including taxes and penalties.
Common qualifying needs, as defined by your plan, may include:
  • Medical expenses for you, your spouse, or dependents.
  • Tuition, fees, or room and board for post-secondary education.
  • Funeral or burial expenses.
  • Costs to prevent eviction from, or foreclosure on, your primary residence.
  • Repairs for casualty damage to your primary residence.
  • Expenses (excluding mortgage payments) to purchase a primary residence.
You may need to self-certify or provide documentation, and other accessible resources (e.g., savings) must typically be exhausted first. Hardship distributions are subject to income tax and, if taken before age 59½, a 10% penalty unless an exception applies. Unlike loans, these withdrawals cannot be repaid, permanently reducing your account balance.

↳ Profit Sharing Loans

If your plan allows loans, you can borrow from your vested account balance without triggering taxes or penalties, provided you repay the loan with interest (typically prime rate plus 1%–2%) back to your account. Failure to repay can result in the loan being treated as a distribution, subjecting you to income taxes and, if under age 59½, a 10% early withdrawal penalty unless an exception applies. The maximum loan amount is the lesser of:

  • 50% of your vested account balance, or
  • $50,000, reduced by the highest outstanding loan balance in the prior 12 months.

To initiate a loan, contact your plan administrator; the process is generally straightforward. Profit-sharing plans often offer two loan types:

  1. General purpose loan – Funds can be used for any purpose (though some plans impose restrictions), with a repayment term of up to 5 years.
  2. Residential loans – Funds must be used to buy a primary residence, often requiring supporting documentation, with repayment terms typically extending up to 10 years.

Repayment requires level payments of principal and interest, made at least quarterly—commonly via payroll deductions—though monthly or more frequent schedules may be allowed. Full repayment is typically permitted anytime, but extra random payments or escalating schedules are often restricted.

If you leave employment before repaying, the outstanding balance may become due immediately; failure to repay results in a taxable distribution, potentially incurring a 10% penalty if under age 59½ and no exception applies. Contact your plan administrator to initiate a loan or confirm specific terms, as rules vary by plan.

In-service Distributions: Non-Hardship Withdrawals

An in-service distribution allows you to withdraw funds from your profit-sharing plan while still employed. Unlike 401(k) deferral accounts, which restrict in-service distributions until age 59½, profit-sharing contributions can be accessed at any age if your plan documents permit. While many plans set a minimum age of 59½, this flexibility—unique to profit-sharing plans—may enable earlier withdrawals based on your employer’s rules. Distributions before age 59½ are subject to ordinary income tax and a 10% early withdrawal penalty unless directly rolled over to another qualified account, such as an IRA. To avoid unexpected tax consequences, review your SPD and plan documents before initiating a withdrawal.

A frequent motivation for an in-service distribution is to pursue alternative investment opportunities. For example, you might roll over your profit-sharing contributions into an IRA via a direct rollover, which avoids taxes and penalties. This allows you to manage the funds according to your risk tolerance and financial objectives, potentially accessing a broader range of investment options.

Rule of 55

The Rule of 55 is an IRS provision that allows penalty-free withdrawals from your profit-sharing plan under specific conditions:

  • You separate from service—voluntarily or involuntarily—in or after the calendar year you turn 55.
  • The withdrawal is from your current employer’s profit-sharing plan, not a plan from a previous employer.

This option can facilitate early retirement by providing access to funds without the 10% early withdrawal penalty. However, distributions are still subject to ordinary income tax, and your employer is not required to permit these withdrawals. Some plans may mandate a full account distribution as a lump sum, which could result in a significant tax liability. To assess its feasibility, carefully review your SPD and plan documents.

Required Minimum Distributions (RMD)

Required Minimum Distributions (RMDs) are mandatory withdrawals from your profit-sharing account, generally beginning at age 73. If you remain employed and own less than 5% of the company, you may defer RMDs from your current employer’s plan until the year you retire, if the plan allows this exception. This deferral applies only to your current plan; RMDs from other retirement accounts (e.g., prior employers’ plans) must start at 73 unless rolled into your current plan.

Missing an RMD deadline triggers a penalty of 25% (or 10% if corrected within two years) on the undistributed amount. Your first RMD is due by April 1 of the year following the year you turn 73, with subsequent RMDs required annually by December 31.

To calculate your RMD, divide your account balance as of December 31 of the prior year by the life expectancy factor from the IRS Uniform Lifetime Table. Each profit-sharing plan requires its own RMD calculation and distribution—aggregating plans for a single withdrawal is not permitted. RMDs are taxed as ordinary income and may be taken as a lump sum or in installments, as long as the annual total meets the requirement. Review your SPD and plan documents for plan-specific rules.

Turning 73? See how your first RMD timeline may work

Option One – Take your first RMD by April 1 of the year after turning 73 and your second by December 31 of the same year. This results in two RMDs in one year, potentially pushing you into a higher tax bracket.

Option Two – Take your first RMD in the year you turn 73 (before December 31) and your second by December 31 of the following year. This spreads RMDs across two years, reducing the likelihood of a higher tax bracket.

Rollovers Out: Profit Sharing Plan

Rolling over your profit-sharing plan can consolidate retirement accounts, reduce fees, or provide access to a wider range of investment options. A direct rollover—where funds are transferred directly between accounts—avoids taxes and penalties, making it a tax-efficient option. Rollovers are most common after separation from service but may also be allowed under other conditions, such as reaching a plan-specified age, depending on your plan’s rules.

↳ Rollover Chart: Which Retirement Accounts Are Allowed To Accept A Profit Sharing Plan Rollover

Type of Account Allowed?
Roth IRA Yes₍₃₎
Traditional IRA Yes
SIMPLE IRA Yes, after two year
SEP IRA Yes
Governmental 457(b) Plan Yes₍₄₎
Qualified Plan ₍₁₎ (pre-tax) Yes
403(b) Plan (pre-tax) Yes
Designated Roth Account (401(k), 403(b), or 457(b)) Yes  ₍₃₎₍₅₎

Additional information: (1)(3)(4)(5)

(1) Qualified plans include profit-sharing, 401(k), money purchase, and defined benefit plans. (3) Must be included in income. (4) Must have a seperate accounts. (5)  Must be an in-plan rollover.

↳ Rollover Profit Sharing Account To an IRA

You can roll your profit-sharing account into a traditional IRA after leaving your job or meeting plan-specific criteria (e.g., an age threshold outlined in your Summary Plan Description). This consolidates accounts, often lowers administrative fees, and offers greater investment flexibility to align with your risk tolerance and goals.

However, it may complicate backdoor Roth IRA contributions due to the IRS pro-rata rule. Additionally, if you’re still employed at age 73, IRAs require Required Minimum Distributions (RMDs), whereas your profit-sharing plan might defer them until retirement if you own less than 5% of the company and the plan permits.

Alternatively, you can roll into a Roth IRA, converting the funds to after-tax status. This triggers ordinary income tax on the rollover amount in the year of conversion, but you might strategically time it for a low-income year to secure a lower tax rate. Once in a Roth IRA, funds grow tax-free, RMDs are eliminated, and qualified distributions—after age 59½ and a 5-year holding period—are tax-free, provided IRS requirements are met.

↳ More on Rollovers: Individuals Can Perform a Rollover in The Following Ways

  1. Direct rollover – An account holder must request instructions from their plan administrator. Typically, a check is made payable to the new 401(k) or IRA custodian (e.g., “Fidelity Investments FBO [Your Name]”) and sent directly to the new plan. No taxes are withheld from the transfer amount because the funds do not pass through the individual’s hands.
  2. Trustee-to-trustee transfer – The trustee or custodian of one plan transfers the rollover amount directly to the trustee or custodian of another plan. This is common for IRA-to-IRA transfers. No taxes are withheld, and the individual does not take possession of the funds.
  3. 60-day rollover – If a distribution from an IRA or retirement plan is paid directly to you (e.g., a check in your name), you can deposit all or a portion of it into an eligible retirement plan within 60 days. For distributions from a retirement plan like a 401(k), taxes (typically 20%) are withheld, so you’ll need to use other funds to roll over the full pre-tax amount. For IRA distributions, taxes are not automatically withheld unless requested.
    • Note: Only one IRA-to-IRA 60-day rollover is allowed per 12-month period (this limit does not apply to direct rollovers, trustee-to-trustee transfers, or rollovers involving employer plans).

Review your SPD and plan documents to confirm rollover eligibility and tax implications.

Inheritance and Death

When you pass away, the assets in your profit sharing plan are transferred to your designated beneficiary or beneficiaries. What happens next depends largely on who inherits the account. A surviving spouse has the greatest flexibility: they may roll the funds into their own IRA or choose to transfer them to an inherited IRA. Non-spouse beneficiaries—such as children or other individuals—are typically required to transfer the assets to an inherited IRA and must generally withdraw the full balance within 10 years, under current IRS rules. For specific guidance, it’s important to review your plan documents, consult your plan administrator, or refer to the inherited IRA page.

FAQs

How much will my employer contribute to my profit-sharing plan each year?

It varies—contributions are discretionary and often tied to profits. Your employer decides the amount and allocates it using a formula in the plan documents. There’s no guarantee of a contribution every year.

When do I become fully vested in my profit-sharing plan?

It depends on your plan’s vesting schedule: immediate (right away), cliff (e.g., 100% after 3 years), or graded (e.g., 20% per year over 6 years). Check your plan documents to see your timeline.

Can I withdraw money from my profit-sharing plan while still employed?

Maybe—if your plan allows in-service withdrawals, you can access vested funds, but withdrawals before 59½ may trigger a 10% penalty plus taxes unless an exception applies. Ask your plan administrator.

How are distributions from my profit-sharing plan taxed?

Distributions are taxed as ordinary income in the year you receive them. If you withdraw funds before age 59½, you may also owe a 10% early withdrawal penalty unless an exception (like disability or separation after age 55) applies. To avoid taxes and penalties, you can roll over the funds into another retirement account, such as an IRA.

What happens to my profit sharing plan if I leave my job?

Once you leave, your employer or plan administrator will inform you of your vested balance and your options. These typically include:

  1. Leave It in the Plan
  2. Rollover to an IRA or New Employer’s Plan
  3. Cash It Out

Does having a profit sharing plan limit my ability to contribute to an IRA?

No, investing in a profit sharing plan does not inherently limit your ability to contribute to an IRA, but there are specific IRS rules and eligibility factors that may affect your ability to make deductible or nondeductible IRA contributions based on your profit sharing plan participation.

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