3751 / What special qualification requirements apply to profit sharing plans but not to pension plans?

A profit sharing plan is a defined contribution plan that allows for discretionary employer contributions (as opposed to a money purchase pension plan with a fixed contribution as a percentage of participant compensation). Because employer contributions are discretionary, they can be a means for sharing employer profits with employees and their beneficiaries. All 401(k) plans must be profit sharing plans. A profit sharing plan must provide (1) a definite predetermined formula for allocating contributions and trust earnings among the participants, (2) for periodic valuation of trust assets, and (3) for distribution of the funds accumulated under the plan after a fixed number of years (meaning at least two years), on the attainment of a stated age, or on the prior occurrence of some event such as layoff, illness, disability, retirement, death, or severance of employment ( Q 3749).¹

Profit sharing plans (as opposed to money purchase pension plans) have few restrictions on distributions. The IRS has ruled that a plan could permit participants with at least five years of participation to withdraw all employer contributions (including those made during the last two years).² With respect to amounts rolled over from another qualified plan, the receiving profit sharing plan must comply with the “fixed number of years” requirement without reference to the number of years such amounts accumulated in the previous plan.³ Where a participant’s entire account balance transfers to another qualified plan, the years of participation in both plans may be aggregated.⁴

It is not necessary that the employer contributes every year, contributes the same amount every year, or contributes in accordance with the same ratio every year. Merely making a single or occasional contribution for employees, however, does not establish a profit-sharing plan. To be a profit-sharing plan, there must be recurring and substantial contributions.⁵