Share The Wealth

Think the world of profit-sharing plans begins and ends with the 401(k)? Think again.
Magazine Contributor
5 min read

This story appears in the September 1997 issue of Business Start-Ups magazine. Subscribe »

Q. Our privately owned 100-employee company is looking into setting up a profit-sharing plan. We are aware of some different types of plans, but we'd like to look at what other companies are doing. I would appreciate any recommendations you can make as to model plans or experts we can speak with.

Travis Allen

Via the Internet

A. Donna Hopson is president of Hopson Pension Services Inc. in Tustin, California, and past president and current education chair of the National Institute of Pension Administrators:

As you are probably aware, the 401(k) plan has been the most popular and publicized type of profit-sharing plan for companies of any size during the past few years. Internal Revenue Code Section 401(k) permits profit-sharing plan participants to defer part of their before-tax compensation to the plan. Popularity does not always equal success, however, and 401(k) plans often fail to perform as desired due to complex nondiscrimination rules designed to prevent highly compensated employees (HCEs) from obtaining greater benefits than lower-paid employees. An HCE is defined as any employee earning more than $80,000 in 1997, and any company owner. The maximum average percentage of pay that HCEs can defer is limited to 2 percent more than the average percentage deferred by lower-paid employees. Since lower-paid employees tend to have less discretionary income, their average deferral percentage is normally low, thus restricting what HCEs are able to defer.

Fortunately, there are ways to increase contributions to a profit-sharing plan. One way is by making matching contributions. The assurance that a portion of every contribution made by an employee will be matched by the employer usually results in increased deferral rates among lower-paid employees. It's common to see a 25 percent or 50 percent employer match on deferrals of up to 6 percent or 8 percent of an employee's pay.

Contributions and allocations are a component of all profit-sharing plans whether they contain 401(k) benefits or not. The contributions are company-funded and allocated to each employee who has met the plan's eligibility requirements.

During the past few years, legislative changes have added flexibility to the allocation of profit-sharing contributions through the use of age-weighted and rate group plan design. Both age-weighted and rate group plans are subject to complex nondiscrimination tests, which increase administrative and consulting fees but permit flexibility in the distribution of benefits.

There are four common methods of allocating a company profit-sharing contribution:

1. Everyone who is eligible receives the same percentage, based on compensation.

2. Social Security benefits are factored into the allocation, providing slightly higher contributions for salaries that exceed the Social Security wage base.

3. Age-weighted plans allocate the contribution according to the participants' ages, based on the premise that the older person has fewer years in which to accumulate funds.

4. Rate group plans specify contributions for specific groups of employees (by job description), thus permitting varying levels of benefits.

Independent third-party administrators and consultants can help you select and set up a profit-sharing plan; look in the Yellow Pages under "Pension/" or "Retirement Plans."

Q. How do I determine market potential in my local area?

Name withheld

Via the Internet

A. Shannon Dortch is senior editor of American Demographics magazine in Ithaca, New York, and an authority on the . She writes that magazine's monthly "Tomorrow's Markets" column, which profiles future growth markets:

First, define the geographical boundaries of your market. Next, look up estimates to determine how many people live in your geographic market. To do the job right, study the population of your market by age, not just overall. There are several excellent data sources. Every state has a Census Bureau-affiliated state data center, usually housed at a major university. Many of these state data centers produce their own population projections by age. To find your state data center, contact the Census Bureau at (301) 457-1305.

Private companies also compute reliable estimates and projections. (Any population figure other than those from the decennial census is an estimate or projection since the population is only counted every 10 years.) One independent source is Woods & Poole Economics Inc. of Washington, DC, which can be reached at (800) 786-1915.

Because not every adult in your market buys your type of product, find out who does or who engages in behavior that makes them a potential customer. Trade groups and associations often do and offer this kind of data at a reasonable cost to members. There are also private sources, such as Simmons Market Research Bureau Inc. and Mediamark Research Inc., both in New York City. Searching newspaper and magazine databases at the local library may also yield statistics.

Expanding your market can be a challenging proposition. Taking the steps I've described to determine the market potential accurately will give you a good foundation and help keep you ahead of the game.

Contact Sources

American Demographics, (800) 828-1133

Hopson Pension Services Inc., (714) 665-6940, fax: (714) 665-6945.


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