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

A provision for offsetting contributions under a profit sharing plan by contributions made to a money purchase pension plan will not prevent either plan from qualifying.⁶

In a profit sharing plan, an age lower than 65 may be specified as retirement age.⁷

Withdrawal of Contributions

If a plan provides that employer contributions are allocated on the basis of employee contributions that may be withdrawn immediately after they are made, the plan will not qualify because such a withdrawal provision “could reasonably be expected to result in the manipulation of the allocation and contravention of the definite predetermined allocation formula requirement of Section 1.401-1(b)(1)(ii) of the regulations.”⁸

If, on the other hand, the withdrawal provision imposes a “substantial limitation” on the right of a participant to withdraw his or her own contributions, so that the provision “cannot reasonably be expected to result in the manipulation of the allocation” as described above, this provision will not cause a plan to fail to qualify.⁹

Valuation of Assets

If amounts allocated or distributed to a particular participant are to be ascertainable, the plan must provide for a valuation of investments held by the trust at least once a year, on a specified inventory date, in accordance with a method consistently followed and uniformly applied. The fair market value on the inventory date is to be used for this purpose. The respective accounts of the participants are adjusted in accordance with the valuation.¹⁰

If a fully insured profit sharing plan provides that all trust assets are to be invested immediately in individual annuity or retirement income contracts, the cash value of which at any particular time is contained in a schedule supplied by the insurance company, the plan need not provide for the periodic valuation of trust investments.¹¹