Employer Contribution Considerations: Is a Profit Sharing or Matching Contribution Right For My Organization?
There are a variety of different types of employer contributions out there, and like everything else, they all have upsides and downsides. According to the Profit Sharing Council of America’s 61st Annual Survey, the average employer contribution made to a Defined Contribution retirement plan equals about 6.2% of salary for financial service industry employers. About half of plans (54.6%) offer a matching contribution. Another 9.9% offer only a non-elective contribution (for example, a profit sharing contribution), and the remaining 31.8% of employers offer both.
What Kinds of Contributions Are Out There?
Matching and profit sharing contributions represent the primary two types of contributions that are seen in 401(k) plans. A matching contribution can be based on a specific amount of employee contribution (a 50% match on the first 6% of an employee’s contribution, for example). Less commonly, it can be tiered, based on an employee’s years of service.
A Closer Look At Match
Matching contributions are only made to those employees who actually contribute to the plan. Therefore, not everyone will receive the full match, or even any employer contribution at all if they don’t contribute themselves. However, matching contributions have their upsides – it incentivizes employees to contribute – “don’t leave money on the table” is a powerful motivator. From a cost perspective, it may (depending on the structure) be less costly than a non-elective contribution, but costs may also be more volatile.
A Closer Look At Non-elective Contributions
Non-elective contributions are made to everyone who is eligible, regardless of their contribution status. Non-elective contributions take many forms and names – they also are frequently referred to as “basic” or “profit sharing” contributions.
These types of employer contributions are generally made on a pro-rata basis to employees, based on compensation, and may or may not be integrated with the Social Security Covered Compensation limit. Non-elective contributions can be good, because not everybody can afford to contribute all the time and those are the very people who may benefit most from an employer contribution. However, some plans with only non-elective contributions may see lower employee deferral rates – “save up to the match” is a commonly shared adage among many savers.
Making Both Contributions: Best of Both Worlds?
Some employers choose to use both contribution types in their plan. Let’s take an example: ABC Corp currently uses a matching contribution equal to 100% of the first 6% of employee contributions. They have a multitude of competing goals: they want to incentivize employees to contribute, but also provide a baseline level of contribution to everyone. Instead of their current structure, they could offer a match equal to 50% of the first 6% in contributions, plus a 3% annual profit sharing contribution. This structure wouldn’t cost more for ABC Corp, and it would have the additional goal of encouraging at least 6% in employee contributions. Plus, everyone would at least get something.
An employer can even attach allocation conditions to a profit sharing contribution. For example, only employees who work 1,000 hours, or those who are employed on the last day of the year (or both), could be eligible to receive the contribution.
Which Is Right?
A matching contribution may be right for your organization if you:
- Want to incentivize people to contribute
- Are okay with some cost volatility (as people enter/exit the plan, change contribution rates, etc.)
A non-elective contribution may be right for your organization if you:
- Want to provide employees with a baseline level of retirement income
- Would like to add allocation conditions for the contribution
Remember, you can even offer both contribution types if you choose. Both matching and non-elective contributions can be offered in Safe Harbor format, which is a special contribution type that relieves the employer of certain annual nondiscrimination testing (ADP & ACP test). Some plan documents also permit for supplemental (also called discretionary) contributions. These generally take the shape of a uniform percentage of an employee’s salary (match) or compensation (non-elective). The difference between the supplemental contributions discussed here, and the ones discussed above, is that these contributions are not required to be made, offering even more flexibility to employers. Supplemental contributions may be made alone, or alongside any of the contribution types already discussed above.
The bottom line: whichever contribution type you choose, you have plenty of options and flexibility as an organization. Not to mention, you’ll be providing your employees with a valuable benefit for their futures!
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