Many smart companies are offering profit-sharing plans to their employees as a way to attract the best workers and create loyalty within the business. These plans are not only a great way to boost annual income, but can also be used to fund retirement plans.
If your company offers a profit-sharing plan, you will be faced with a choice. You can accept cash payments, which of course will be taxable as regular income. You may certainly invest the money if you’d like, but you will be paying taxes first because you accepted the cash payment. The other option is to use these payments to fund your retirement and defer taxes on the money at the same time. If your employer offers an elective deferral plan, you can funnel these payments into your retirement fund and the money will accumulate with taxes deferred.
Companies have different rules concerning which employees may enroll into the profit-sharing plan, often concerning age or length of employment. The rules concerning taxes and contribution limits, of course, are uniform no matter where you work. In 2013, companies are allowed to contribute either 51,000 dollars or 25 percent of each employee’s salary (whichever is less) to a profit-sharing plan*. These limits are reassessed and indexed for inflation when appropriate. Once you’re fully vested in the profit-sharing plan, you are able to roll over the full amount contributed by your company and roll it into an IRA. In the event that you ever change employers, you will be able to roll your old account into your new one.
Withdrawals before age 59 ½ may be subject to a 10 percent early withdrawal tax penalty. After this point, withdrawals are taxed as regular income. While these rules are fairly uniform across all profit-sharing plans, some employers do offer programs with more flexibility. In certain cases early withdrawals are allowed.
Between age 59 ½ and 70 ½, withdrawals are optional. After age 70 ½, most plans will require you to take at least the minimum distributions. You have the choice to receive your funds as a lump sum, with taxes due on the entire value of the fund, or arranging a distribution schedule that fits your needs.
If your company offers a profit-sharing plan, it is often best to utilize the program to save for retirement. Try to think of the extra money as a bonus that you won’t miss each year, that will someday add up to a very valuable gift to yourself in retirement.