This type of profit sharing plan uses an allocation formula to divide employees into groups; classifying them as “preferred” and “non-preferred.” Based upon relative age and compensation, contributions are allocated within each group. Adding a 401k salary-deferral option is allowed with this type of Plan design. Complex actuarial contribution calculations and nondiscrimination testing are typically associated with these types of plans.
This type of plan is a defined benefit plan, not a defined contribution plan, which defines a “pay credit” and an “interest credit” for each participant, which can be fixed or linked to a variable rate. When a participant becomes entitled to his or her benefit, typically upon retirement, a participant may have the option to collect the benefit via annuity-type payments based upon his or her account balance, or as a lump-sum payment.
Commonly referred to as pension plans, the employer, not the employee, funds this type of plan and it promises participants a specific monthly benefit upon their retirement. Benefits are often calculated factoring an employee’s age, years of service, and salary. The Federal Employee Retirement Income Security Act (ERISA) plans are in most cases, insured by the Pension Benefit Guaranty Corp.