An InSightful Guide to Profit Sharing for Plan Sponsors

Financial Planning Dentist

At InSight, we encourage profit sharing as a valuable option within a 401(k) plan, allowing employers to make pre-tax contributions to their employees’ retirement accounts at the end of the year. Contrary to its name, profit sharing doesn’t necessitate that your organization generates profits for the year. Instead, it provides flexibility for rewarding employees with additional retirement contributions based on your discretion.


Why You Should Consider Profit Sharing:

There are numerous advantages to making profit-sharing contributions, including:

  1. Tax-Deductible Contributions: Profit-sharing contributions are typically tax-deductible for the previous tax year.
  2. Financial Assessment: You can assess your finances before deciding the amount to contribute.
  3. No Minimum Requirement: No minimum amount for profit-sharing contributions exists.
  4. Contribution Limits: While profit-sharing contributions don’t count toward the annual deferral limit, they are limited to 25% of eligible compensation (the deduction limit) for the plan year. Additionally, total contributions per participant can be at most $66,000 ($73,500 with catch-up contributions) for 2023 (the annual additions limit).
  5. Inclusive Contributions: You can contribute to all employees, even those who don’t personally contribute.
  6. Vesting Options: Vesting schedules can be chosen to incentivize employee retention.

Please note that if your business is part of a legally related group, you may be obligated to distribute profit sharing across all entities involved.


How to Make Profit-Sharing Contributions:

InSight simplifies the process of implementing profit-sharing plans. If you plan to make a profit-sharing contribution, follow these steps:

  1. Verify Plan Settings: Ensure that your plan includes the desired profit-sharing allocation formula.
  2. Formula Options: Pro-rata and flat dollar profit-sharing formulas are available for InSight Core and Enterprise plans. New comparability is also an option for Enterprise plans or can be added for a fee in Core plans.
  3. Initiate Profit Sharing: InSight will create a profit-sharing task on your administrator dashboard in the first quarter after receiving compensation data. Simply complete this task to initiate profit sharing.
  4. Confirmation Notice: After your request is submitted, InSight will provide you with a confirmation notice to review before processing the profit-sharing contributions.

For more details on the availability of profit sharing and specific timelines, please refer to our resources.

This guide aims to help plan sponsors navigate the profit-sharing process with ease, providing a valuable benefit to both employers and employees.

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The Crucial Role of Standard Deviation in Investment: Why It Matters

When it comes to making smart investment decisions, there are various factors to consider, such as potential returns, risk tolerance, and time horizon. However, one often overlooked but essential metric is the standard deviation. Standard deviation is a statistical measure that can provide valuable insights into the volatility and risk associated with an investment. In this blog post, we will explore why knowing the standard deviation on an investment is key and how it can help investors make more informed choices. Understanding Standard Deviation Before delving into why standard deviation is crucial in investment, let’s take a moment to understand what it represents. Standard deviation measures the dispersion or variability of a set of data points. In the context of investments, it quantifies the level of risk associated with a particular asset or portfolio. Here’s a simplified explanation: Imagine you have two investment options. Option A consistently returns 7% per year, while Option B’s returns fluctuate wildly, ranging from -10% to 20% each year. Even though both options might have the same average return (7%), Option B’s returns are much more unpredictable and volatile. Standard deviation helps us quantify this variability and risk in Option B’s returns. Now, let’s explore why knowing the standard deviation is crucial for investors. Risk Assessment The primary role of standard deviation in investment is to gauge the level of risk. As mentioned earlier, a higher standard deviation indicates greater variability in returns, which can be a sign of higher risk. Investors with a lower risk tolerance may prefer investments with lower standard deviations because they provide a more stable and predictable stream of returns. Portfolio Diversification Diversifying a portfolio involves selecting a mix of assets with different risk and return profiles. Standard deviation helps investors assess how individual assets contribute to the overall risk of the portfolio. By including assets with low or negative correlations and varying standard deviations, investors can create a more balanced and less volatile portfolio. Setting Realistic Expectations Understanding standard deviation can help investors set realistic expectations about potential outcomes. If an investment has a high standard deviation, it means that there is a wider range of potential returns, including the possibility of both significant gains and losses. Knowing this, investors can prepare themselves for the possibility of a bumpy ride and avoid making rash decisions based on short-term fluctuations. Comparison and Selection When evaluating different investment options, standard deviation provides a useful basis for comparison. Comparing the standard deviations of various assets or funds can help investors identify which ones align better with their risk tolerance and investment goals. It allows them to make more informed choices about where to allocate their capital. Risk Management Managing risk is a critical aspect of successful investing. Standard deviation plays a key role in risk management by helping investors assess the potential downside and establish risk mitigation strategies. It enables investors to make choices that align with their risk-reward preferences and long-term financial objectives.   In the world of investment, knowledge is power, and understanding standard deviation is a powerful tool at an investor’s disposal. It provides valuable insights into the level of risk associated with an investment, aids in portfolio diversification, helps set realistic expectations, facilitates comparisons, and supports effective risk management strategies. While standard deviation is not the only metric to consider when making investment decisions, it is a key factor that should not be overlooked. By incorporating standard deviation into your investment analysis, you can make more informed choices, better manage risk, and ultimately work toward achieving your financial goals with greater confidence.

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Investing 101
Peter Locke

Investing 101

If you’re lucky enough to have previously started investing in your teens consider yourself way ahead of the curve. For the majority of people Investing 101 is for you. Most of us start investing in our mid to late 20s, but for those that start as early as possible can set themselves up for an incredibly lucrative future. Where should you start for Investing 101? There are a couple of places that will have the largest impact on your net worth. If, let’s say you have a summer job and you’re making $5,000-$10,000 a summer or you’re working throughout the year then opening an investment account is a great place to start.  For us, saving anyway in any type of account is great. While we like all accounts for different reasons, we like the Roth IRA the most when you’re young. A Roth IRA is like a bank account with different advantages. It enables you to save money that you’ve already paid taxes on and those savings grow tax free until you turn age 59.5 penalty free. Now we love the Roth IRA because typically when you’re young your income is fairly low so taking advantage of low tax rates is a great strategy.  Since you’ll be in the lowest tax bracket in 2020 (things may change in 2021) then paying taxes now for your money to grow tax free for multiple decades can have a profound impact on your wealth. The reason is called compounding growth. Let’s say you make it very easy on yourself and just buy into the SP500. It’s an index that tracks the 500 largest companies and you can invest in all of them using one investment vehicle. Let’s break Investing 101 down. A stock is a way to own a part of a company. An Exchange Traded Fund (ETF) is a basket of stocks that give investors exposure to typically hundreds of companies. Since you cannot buy an index like the Dow Jones, SP500, or Nasdaq (different indices) directly, you have to buy a vehicle that gives you exposure to them. That vehicle can be a ETF, which is usually a less expensive and passively managed investing vehicle when compared to a Mutual Fund. A Mutual Fund (MF) is a basket of stocks just like an ETF that is more actively managed and usually more expensive way to gain exposure to the same stocks. The difference being whether or not you think someone can actively outperform the index (MF) or you just want general exposure to the index (ETF). You can argue both sides so do what makes you feel comfortable. ETFs and MFs have different tax obligations but this isn’t as big of a concern until you’re in higher tax brackets.  If picking stocks is difficult, you aren’t interested in it, or you just want things to be more simple, investing in ETFs is an incredible way to bring you long term wealth.  ETFs and MFs typically pay what’s called a dividend. This dividend is like a thank you from the company for investing in that company. It’s a cash payment to you, typically quarterly, that you can use to reinvest back into your ETF or MF, a new stock, or whatever else.  Think about your investment portfolio like a business. This is the core to Investing 101. Your business takes money and hopefully makes you money. When you make more money you either spend it on yourself or put it back into the company. When you put it back into the company the company grows and makes you more and more money over time. This is a great way to think about investing in an ETF or MF. Every quarter, without you having to work at all, your fund is paying you and you can reinvest that money to grow your portfolio more and more.  Wealth isn’t created overnight. The secret to wealth is long term saving and investing. Hence, those that have time on their side have the greatest ability to accumulate wealth. So what else should you be thinking about?  After investing in yourself first, think about where else you spend your money. We wrote an article on the difference between erosive and accretive debt. If you find yourself buying lots of clothes, expensive shoes, fancy gadgets, and new cars then you’re not investing in your “portfolio business”. When you stop investing in your business you stop growing. Each time you do this the effect is compounded.  For example, if you invested $1,000 and $100 monthly for 40 years at 9% interest rate (average gain of the SP500) you would have ~$436,000 at the end. But let’s say you invested $1,000 upfront and only $50 monthly over the same time period and same interest rate, you’d have ~$234,000! That is a massive difference for only $50. That could be one meal out for you and your significant other, one new shirt you liked that you didn’t need, a car payment on a new car because you didn’t want a used car.

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Why “Loses” can aid real estate investing?

Investors and property owners often welcome “losses” from depreciation on rental properties due to the tax benefits and financial advantages they offer. Here are several reasons why depreciation can be exciting for investors: Tax Deductions:    – Depreciation allows property owners to write off a portion of the cost of a rental property each year, which acts as an expense for tax purposes. This reduces the taxable income generated by the property, leading to lower income tax liability. Although it’s a non-cash expense, depreciation can significantly impact an investor’s cash flow by decreasing the amount of taxes owed. Cash Flow:    – Because depreciation reduces taxable income without affecting cash inflow, it can enhance the cash flow from a rental property. Investors can use the additional cash for further investments, paying down debt, or other financial activities. Leverage:    – Depreciation can also be advantageous when an investor is leveraging their investment with borrowed funds. While mortgage payments may be partly interest (which is usually tax-deductible) and partly principal, depreciation can provide additional deductions, thereby further reducing tax liability and improving cash flow. Time Value of Money:    – The time value of money principle suggests that a dollar today is worth more than a dollar in the future due to its potential earning capacity. Depreciation allows investors to defer tax payments to future years when the value of money may be less, essentially reducing the present value of their tax liability. 1031 Exchange:    – In the United States, the IRS allows property investors to use a mechanism called a 1031 exchange to defer paying capital gains taxes on the sale of a property if they reinvest the proceeds in a similar property. The combination of depreciation and a 1031 exchange can significantly defer tax liabilities and enhance the long-term growth of an investment portfolio. Strategic Exit:    – When selling a property, investors will have to consider depreciation recapture, which taxes the amount of depreciation taken. However, strategic planning and investment in properties with favorable capital gains treatments can help mitigate this tax impact. Portfolio Diversification:    – The tax benefits from depreciation can be particularly appealing for investors looking to diversify their portfolio with real estate. The unique financial and tax characteristics of real estate investments, including depreciation, can provide risk mitigation and returns uncorrelated with other asset classes. While depreciation offers various advantages, investors should also consider the implications of depreciation recapture and the importance of comprehensive tax planning and strategy. It is advisable for investors to consult with financial advisors or tax professionals to optimize the benefits of depreciation and align them with their investment goals.  

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