What is it?
An age-weighted profit-sharing plan is a defined contribution profit-sharing plan where contributions are allocated based on the age of plan participants as well as on their compensation, allowing older participants with fewer years to retirement to receive much larger allocations (as a percentage of current compensation) to their accounts than younger participants.
In a traditional profit-sharing plan, allocations are based on the compensation of plan participants without reference to age. By contrast, an age-weighted profit-sharing plan is a defined contribution plan in which contributions are allocated based on projected benefits at retirement age–the allocations are based on the age of plan participants as well as their compensation.
Because an age-weighted plan is permitted to use the projected retirement benefits at retirement age to allocate current contributions to plan participants, an age-weighted plan can be nondiscriminatory even though two employees earning the same amount have a different contribution made for each of them (because they are not the same age). Simply put, older participants need larger contributions to attain their projected retirement benefit since there are fewer years for those contributions to grow until the older participants reach retirement age. That means that two participants, of different ages, earning the same amount can have different contribution allocations since the younger participant has more years for his contributions to grow until retirement age.
Tip: This type of plan allows older participants (usually the owners and/or key employees) with fewer years until retirement to receive much larger allocations to their accounts each plan year than younger participants so that each participant has the same projected retirement benefit (as a percentage of current compensation) at the plan’s retirement age. These plans use the same type of benefit accruals and calculations you see under defined benefit plans where two plan participants earning the same amounts will have different sized contributions depending their ages–older participants need larger contributions since there are fewer years for those contributions to grow for them. Age-weighted plans may also use years of service or a combination of age and years of service to calculate contributions.
Caution: Age-weighted plans are not the same as new comparability plans. Although both types of plans may be adopted for the same purpose (to increase contributions to certain employees, usually older employees with higher compensation levels), new comparability plans have one extra component to calculate allocations–employees are also grouped into categories and each category may have a different contribution formula.
Tip: Unlike money purchase, target, and defined benefit plans, an age-weighted profit-sharing plan, like other profit sharing plans, allows you the flexibility to determine each year how much or how little you want to contribute to the plan each year (subject to maximum contribution limitations as well as the requirement that, overall, contributions must be recurring and substantial). Consequently, if your business is not doing well, you can decide not to contribute one year and if business turns around down the road, you can decide to make a contribution for that year and subsequent years.