DC Limits and Profit Sharing

When I first joined PSCA there were many DC plans where eligibles received a 15%-of-pay employer profit sharing contribution. For those who wistfully recall this earlier era and wonder why this is no longer true, it results from changes to the federal contributions limitations structure.
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The culprit is a combination of the compensation limit, currently $245,000, and the Section 415 annual additions limit for employer and employee contributions and forfeitures, currently $49,000. (In 1982 there was no compensation limit and the annual additions limit was $40,000.) Plans are designed so legal limits are not violated, especially for those making $245,000 or more. Subtracting the maximum 401(k) contribution of $16,500 from the $49,000 limit leaves $32,500 for matching contributions, profit sharing and forfeitures. This is 13.3% of pay for someone making $245,000. Since most profit sharing plans still have vesting, and thus forfeitures, this means in practice profit sharing contributions are limited to between 12% and 13% of pay if there are no matching contributions.

If there are matching contributions, the potential for profit sharing is reduced further. To illustrate why, I will use the safe harbor matching approach. (22% of plans had this feature in 2009 according to PSCA’s 53rd Annual Survey.)

For someone making $245,000:

• $12,250 The matched elective contribution of 5% of pay.
• $04,250 The additional permitted non-matched elective contribution.
• $16,500 The total employee 401(k) contribution.
• $09,800 A company match of 4% of pay.
• $26,300 The non-profit-sharing subtotal.
• $22,700 Available for profit sharing ($49,000-$26,300).

This means that for someone making $245,000 the maximum profit sharing contribution is 9.3% of pay or in practice between 8% or 9% if there are forfeitures.

There is an important take away here. Since most DC plans now include a 401(k) feature and over 80% of these include matching contributions, we need to preserve the current Section 415 annual additions limit of $49,000 if profit sharing and other non-elective contributions of any significance are to continue.