The rules governing profit-sharing plans have changed. Maybe it's time your plan did, too.
One Monday morning early last year, Vanessa Ogle gathered her staff for a big announcement. The 23 employees of Enseo were expecting bad news. The sluggish economy had been tough on the Richardson, Texas, company, which makes hardware and software that drive media to digital displays like billboards and video-on-demand systems. Staffers had seen their salaries slashed by as much as 15%; Ogle's own pay was sliced in half.
But this meeting was different. Enseo had just landed major contracts with AMC Theatres and a vendor for JetBlue Airways, Ogle announced. As a result, she was reinstating everyone's salaries. In fact, Ogle expected Enseo to turn a substantial profit in the second quarter of 2003 -- and employees would share in that good fortune thanks to a brand-new profit-sharing program. "They had been so supportive," Ogle says. "We wanted to reward them after things turned around."
Enseo already had a 401(k) program in place. But Ogle felt that profit sharing would be a better way to keep her employees' eyes on the bottom line and build on the company's newfound momentum. But the typical profit- sharing plan -- taxable bonuses doled out each profitable quarter -- seemed shortsighted. There had to be a way, Ogle figured, to use incentives to keep people focused on both short-term quarterly targets and long-term strategic matters.
Working with her CFO, Ogle came up with just that. Here's how it works: As anticipated, Enseo turned a profit of about $357,000 in the second quarter of 2003. Ten percent of that profit, or $35,700, landed in the company's profit-sharing pool. Ogle immediately dispersed half that amount to her employees, based on their salaries and job performance. The other $17,850 was funneled into a deferred fund. Ogle did the same for the rest of the year, distributing half of the profit-sharing funds to staffers and stashing the rest.
At the end of the year, when it turned out that the company had ended up in the black, employees had a choice: withdraw their share from the deferred account, pay income tax on it, and pocket it; or place the sum in a fully vested tax-deferred retirement plan. Had the year ended in the red, any money in the bonus account would have been reinvested in the company. Only about 10% of employees opted to leave the money in their accounts, but Ogle expects participation to increase this year, now that her staffers have recovered from their salary cuts.
Ogle's approach -- known as a deferred profit-sharing, or "qualified," plan -- has grown increasingly attractive thanks to new IRS rules expanding the amount of profit employees can put into tax-deferred retirement accounts. As of 2002, the maximum amount increased from $35,000 a year, or 25% of salary, to $40,000 a year, or 100% of salary. But many business owners may not be aware of the changes. Only half of all companies reevaluate their retirement plans annually, according to a 2003 study by the Transamerica Center for Retirement Studies. And only 10% reported making any changes to their company-funded programs, including profit sharing, last year.
That could be shortsighted because in addition to providing incentives, qualified plans also come with tax advantages. Unlike the quarterly cash payouts of the typical profit-sharing plan, contributions to qualified plans are not counted as profit and are thus exempt from taxes. So far, Ogle estimates that her company has cut its tax bill by about $3,000. "It's an immediate tax shelter," says Eric Parmenter, an expert in compensation and benefits issues at Grant Thornton.
Ogle was fortunate to have a CFO who understands such matters. If you lack such in-house talent, expect to pay between $2,000 and $5,000 a year for a recordkeeper to administer a similar program. But it could be a worthwhile investment in your staff. Consider Enseo's office manager, Lisa Frederick. Over the past two years, she has socked away about $3,000 of profits in her retirement fund. "I feel like the company cares about my future," she says. Other employees seem to agree: During the two years before the profit-sharing program was established, turnover at Enseo was about 35%; last year, it was zero.