401(k) Profit Sharing for Small Businesses

Flexible employer contributions: A 401(k) profit‑sharing feature allows employers to decide each year how much to contribute—or whether to contribute at all—based on business performance.

Tax-advantaged plan design: Profit‑sharing contributions are tax deductible for employers and can help boost long‑term retirement savings for employees.

Administrative and fiduciary considerations: Because profit sharing can add complexity to a 401(k) plan, many employers work with a plan administrator to help manage compliance and ongoing responsibilities.

When it comes to year‑end tax planning, many small business employers look for flexible ways to lower taxable income while investing in employee benefits. 401(k) profit sharing is a flexible and tax‑efficient way to reward employees by adding money to their retirement accounts when business is good—without committing to a set amount every year.

What is 401(k) profit sharing?

Profit sharing is when an employer decides to put extra money into employee retirement accounts at the end of a profitable year.

How profit sharing works

You decide which employees qualify, within the confines of the IRS nondiscrimination rules
You choose if you want to put money in, and how much, based on how your business is doing that year. This flexibility allows employers to scale contributions up or down depending on cash flow.
For the years when you do make contributions, you add the money to employee retirement accounts at the end of the year (similar to a year-end bonus)

Profit sharing vs employer match

Profit sharing is very similar to a 401(k) match with one key difference:

A 401(k) match requires employees to contribute their own money first
With profit sharing, you can contribute even if your employees don’t

But why would an employer want to share a portion of the company’s yearly profits among employees rather than keep it? There are actually some very good reasons.

Benefits of offering profit sharing

Implementing a profit sharing plan and adding some extra money into your employees’ 401(k) accounts shows your staff that they were a critical part of the company’s success. But profit sharing isn’t just an employee benefit; there are many benefits for employers as well, including:

Flexibility

Profit sharing plans provide ultimate flexibility for the business owner, allowing them to set their own eligibility requirements and vesting schedules, determine distribution triggers, decide if the plan allows for loans, and elect how much to contribute to employees—or whether to contribute at all.

Once the profit sharing contribution is deposited into the plan, it’s divided among the participants according to the allocation method chosen in the plan document. The most common is pro-rata, where each participant shares in the contribution based on the ratio of their compensation to the total compensation of all participants. For example, simply electing to give everyone the same percent of their pay—say 3%.

Another popular technique that works in certain situations is to divide the employees into groups and then allocate specific amounts to each group. For example, compensation level or years of service. If this method is used, the groups must be defined ahead of time in the plan document.

Additional methods include giving all employees a flat dollar amount—for example, everyone gets $1,000—or integrating Social Security.

Tax-friendliness

Similar to other retirement savings vehicles, like 401(k) plans, employer contributions to a profit sharing plan are tax-deductible for the company the year they’re made. Businesses have until the tax return due date, plus extension, to contribute profit sharing funds to the 401(k) plan for the previous year. For example, if the fiscal year is the calendar year, the deadline for partnerships and S-corps would be March 15 and the deadline for sole proprietorships and C-corps would be April 15.

This gives business owners a chance to review yearly profits, determine whether to utilize profit sharing, and decrease the company’s taxable income—all before filling annual business taxes.

Plus, since earnings in profit sharing plans generally aren’t taxed by Federal or state governments until the funds are withdrawn, business owners are gaining tax advantages on an individual level as well. Additionally, small plans may qualify for a tax credit for employer contributions for the first five years.

Attracting and retaining talented employees

According to a post-pandemic study, 82% of workers agree that retirement benefits offered by a prospective employer are a major factor in their final decision when job hunting.1

Workers expect help from their employers with preparing for retirement, and adding an extra boost into their 401(k) account at the end of the year goes a long way in showing employees that you not only care about their financial future, you’re willing to go above and beyond to help them become more retirement ready. Unlike an employer match in a 401(k), employees don’t need to be contributing to their retirement account to earn the profit sharing contribution.

Tax and compliance considerations: How to structure your profit sharing plan

To set up your profit sharing plan, start by deciding how much each employee should receive. Just remember, highly compensated employees can’t be favored over other employees, or your plan won’t pass compliance testing. This helps ensure fair treatment across the workforce. Everything must be clearly stated in your plan document, and generally there are limited opportunities to make a change during the plan year. You may want to contact a trusted financial advisor or other small business retirement plan professional for help with this.

Most commonly, profit sharing contributions are a once-per-year lump sum deposit into the participant’s account—usually at year-end after you’ve had a chance to evaluate business earnings and determine how much you’ll contribute.

Employers have until their tax filing deadline, plus any extensions, to establish a 401(k) plan for the prior year. However, it’s important to keep in mind that a retroactive adoption of a plan like this only allows the employer to make a profit sharing contribution for the prior year (also known as profit sharing only). That means employees can’t add their own money, and the employer can’t offer a match for that year.

For example, before tax filing deadlines in 2026, a business owner could adopt a plan and decrease their tax liability for 2025 by making a profit sharing contribution to the new plan for the 2025 plan year. In 2026, the employer and employees would then be able to make deferral contributions to the plan.

It’s also important to be aware you’ll be taking on some hefty responsibilities when you introduce a small business 401(k) profit sharing plan. If you choose to take on plan management and operation by yourself, you’ll be accountable for the essential elements of running the plan, like making timely contributions, following vesting schedules, passing non-discrimination testing, acting as a responsible fiduciary, disclosing plan information to eligible employees, distributing benefits, and filing year-end reporting—to name a few.

Many plan sponsors choose to hire a plan administrator to help operate their plan and stay in compliance. There are some retirement plan providers that take things a step further—helping to relieve the plan sponsor of many of these responsibilities and limiting the plan sponsor’s fiduciary liability.

Profit sharing 401(k) checklist

It can be hard to determine whether profit sharing is a good option for your small business without in-depth research and vetting, but the Department of Labor (DOL) provides a helpful checklist to help employers determine if they’re ready to offer a plan that will work together with their 401(k).

Before deciding to offer a profit sharing plan, employers should:

Decide whether to hire a financial institution or retirement plan professional to help set up and run the plan
Determine whether to arrange a trust for the plan assets or solely utilize insurance contracts
Develop a recordkeeping system (or hire a recordkeeper)
Decide how much to contribute to the plan
Determine and understand your fiduciary responsibility as it relates to the plan
Understand the reporting and disclosure requirements of the plan
Adopt a written plan document that includes the features you’d like to offer (such as contribution allocations, eligibility requirements, vesting schedules, etc.)
Notify eligible employees and provide them with plan-related information

Ready to get started?

Once you understand how 401(k) profit sharing works and what’s involved in managing it, the next step is determining whether it fits your business goals, cash flow, and administrative capacity.

For additional help in deciding if a 401(k) profit sharing plan is right for your small business, call an Ascensus retirement plan professional at 800-345-6363.