Understanding Profit-Sharing Plans for Highly Compensated Employees

Profit-sharing plans allow plan sponsors to create a flexible retirement benefit structure for their participants. These plans, often integrated with existing 401(k) features, allow employers to make discretionary contributions based on the company’s profitability. For highly compensated employees (HCEs), profit-sharing contributions can significantly supplement traditional retirement savings, but careful planning is required to ensure compliance. Here, Meghan Hannon, CRPS®, CPFA®, Partner and Head of Retirement Plan Consulting, provides insights into how profit-sharing plans can complement employer 401(k) plans for HCE compensation.

Flexibility in Contributions

One of the most appealing aspects of profit-sharing plans is their flexibility. Contributions are entirely discretionary, meaning plan sponsors can decide each year whether to contribute and how much. This feature provides financial adaptability, enabling companies to align contributions with their fiscal performance without potentially over-committing. In addition to this flexibility, the IRS permits several methods for allocating profit-sharing contributions, each offering unique benefits and compliance requirements. These methods can be combined with other plan features to create a customized design that meets the needs of both employers and employees, including HCEs.

Common Allocation Methods

The salary proportional method is straightforward, distributing contributions as a uniform percentage of each participant’s compensation. For example, if the company elects a 5% allocation, every eligible employee receives a contribution equal to 5% of their pay. While this method ensures consistency across participants and is easy to administer, it may not fully address the unique retirement savings needs of HCEs.

Another method, permitted disparity or Social Security integration, allows for additional contributions on compensation exceeding the Social Security Wage Base ($176,100 for 2025). By allocating a uniform percentage of total compensation to all eligible participants and an additional percentage to earnings above this threshold, this method acknowledges the disparity in Social Security benefits for higher earners. It provides HCEs with greater contributions while adhering to nondiscrimination rules.

For companies aiming to direct contributions toward senior personnel or HCEs, the new comparability method, or cross-testing, offers an effective solution. This approach allows targeted contributions by grouping participants and allocating amounts based on specific criteria, like those nearing retirement. However, it requires gateway contributions for non-highly compensated employees (NHCEs) and involves nondiscrimination testing to ensure that benefits for HCEs are not disproportionately higher than those for NHCEs. Although highly customizable, success depends heavily on their unique workforce demographics, and sponsors should work closely with experienced 401(k) plan advisors to navigate its complexities and adjust allocations as their workforce changes.

Key Considerations for Plan Sponsors

When implementing profit-sharing plans, plan sponsors must consider several key factors. Amendments to the allocation methods specified in the plan document typically need to be finalized by the plan year’s end. Compliance with nondiscrimination tests is essential to avoid penalties or required adjustments, and clear communication with employees, particularly HCEs, about the advantages of profit-sharing contributions is crucial. These plans can bridge the savings gap for HCEs, whose retirement contributions are often capped by IRS limits. By leveraging permitted disparity or new comparability, plan sponsors can strategically enhance HCE benefits while maintaining equity and compliance.

Helping You Get There…

A well-designed plan can balance the needs of your workforce, incentivize key personnel, and support long-term financial goals. Profit-sharing plans can become a cornerstone of your company’s strategy for fostering financial security and success for all employees by choosing the proper allocation methods and maintaining compliance. Connect with Meghan to explore how profit-sharing contributions can complement your unique employer 401(k) plan and its participants.